How Do I Calculate a Mortgage Rate After Income Taxes?

The after-tax mortgage rate accounts for the mortgage interest tax deduction.

The after-tax mortgage rate accounts for the mortgage interest tax deduction.

The Internal Revenue Code allows you to deduct the interest on your mortgage from your income taxes. However, depending on your financial circumstances, it might not be in your best interests to take the deduction, in which case your after-tax mortgage rate will be the same as the stated mortgage rate.

Simple Formula

To figure your mortgage rate after income taxes, subtract your marginal tax rate from 1 and multiply the result by your mortgage interest rate. Say for example, you fall in the 25 percent tax bracket and your mortgage interest rate is 5.5 percent. First, subtract 0.25 from 1 to get 0.75. Then, multiply 0.75 by your mortgage interest rate of 5.5 percent to find the after-tax mortgage interest rate is 4.125 percent.

Marginal Tax Rate

As the formula shows, the higher your marginal tax rate, the more your mortgage interest deduction helps you. Your marginal tax rate refers to the rate you pay on your last dollar of income. The brackets vary depending on your filing status and change from year to year. For example, say the tax brackets for the year are 15 percent on income up to $35,000, 25 percent on income between $35,000 and $70,000, and 35 percent on income over $75,000. If your income for the year, before accounting for the mortgage interest deduction, is $90,000, your marginal tax rate is 35 percent.

Only Itemizers Benefit

The only way you actually save money with your mortgage is to itemize your deductions. To itemize, you must give up your standard deduction. If your mortgage interest plus your other itemized deductions, like charitable donations and state and local taxes, don't exceed your standard deduction, your mortgage won't lower your taxes. For example, say you're married and your standard deduction is $12,000. If you pay $8,000 in mortgage interest and have $3,000 in state taxes, your itemized deductions total $11,000, so you're better off not itemizing and your mortgage hasn't helped you 1 cent on your taxes.

Overstated Benefits

Even if you do itemize, your benefits may not be as large as the formula implies. See, only the amount of your mortgage interest in excess of the standard deduction really saves you any extra money on your taxes. For example, say you're married, your standard deduction is $12,000 and you have $4,000 in itemized deductions besides mortgage interest. If you pay $10,000 in mortgage interest, you benefit by itemizing because your $14,000 in itemized deductions exceeds your $12,000 standard deduction. However, instead of your mortgage interest deduction reducing your taxable income by $10,000, it really only reduces it by $2,000 because you could have claimed the standard deduction without it.


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