The mortgage interest deduction is one of the more popular tax breaks Americans use to reduce their taxable income. But what is the mortgage interest deduction, and how much can homeowners qualify for?
In the video segment below, Motley Fool analysts Kristine Harjes and Nathan Hamilton talk about the mortgage interest deduction, how it works, and the annual limits.
Kristine Harjes: One great thing about having a mortgage is that the federal government actually incentivizes having a mortgage by giving you a tax break.
Nathan Hamilton: Yeah. So looking at the mortgage interest deduction, and some people may know about it since it is such a popular tax break, but we figure we'll get into some of the details in a few minutes and discuss, "What is it? How much can you take? What does it mean for your finances?" Specifically, what is the mortgage interest deduction if you itemize your tax statements every year? This is something that you can reduce your taxable income by the full amount of interest that you pay on your mortgage with some caveats.
Harjes: Right. So one thing that I thought was interesting about this is that you can apply to not just your first home but also your second home.
Hamilton: Yeah, it essentially applies to your first and second home. If you're lucky enough to have a third home. I know most of us have the second one. If you're lucky enough to have a third one, then you can apply it. But it applies to what they call "home acquisition debt." ... Home acquisition debt is when you borrow to buy, build, or substantially improve your home.
Harjes: Right. When you buy the house, it's not just necessarily the mortgage interest itself put into that. It's also the improvements that you make to the home. Am I understanding that correctly?
Hamilton: Yeah, if you're using debt to fund those. Plus, there is a $100,000 kicker of home equity debt. If you tally it all up of what you can take [as] a mortgage interest deduction, [it's] $1.1 million. So looking at the numbers here, I ran it just to see, OK, how much interest would I incur if I had $1.1 million worth of mortgage, home acquisition debt, and home equity debt. In the first year, I'd be able to reduce my taxable income by about $43,000, which is significant if you think about it.
Harjes: That's incredible. That is a huge number, and I think that that's something worth keeping in mind if maybe you're on the fence about getting a mortgage. Of course, you don't want to go buy a more expensive home just to get this interest deduction, but it's definitely something to keep in mind and to know about.
Hamilton: I mean, this is the far-out scenario, but it does highlight that, OK, if you have a $200,000 home, if you have a $300,000 home, it is a pretty significant deduction for you.
Harjes: Absolutely. It's one of many things that people should know about and keep in mind when they're doing their research about mortgages. If you're looking for more great tips and tricks, check out fool.com/mortgages. There, we have compiled a ton of helpful mortgage tools, including access to highly rated lenders with low rates. While you're there, you can also download our free guide, "5 Tips to Increase your Credit Score Over 800."