Does Mortgage Interest Help on Taxes?

by Annabella Gualdoni, Demand Media
    Mortgage interest on a vacation property is also tax deductible.

    Mortgage interest on a vacation property is also tax deductible.

    The mortgage interest for a home loan is tax deductible. The home mortgage interest deduction is much lauded, but is sometimes overrated and a bit misunderstood. It is a tax advantage that has helped millions become homeowners, and it can save you thousands of tax dollars a year.

    Tax Credit vs. Tax Deduction

    Many taxpayers do not realize that there is a difference between a tax deduction and a tax credit and mistakenly believe the two are interchangeable. When you receive a tax credit, the amount of taxes you pay that year is reduced by the amount of the credit. With a tax deduction, your amount of income is reduced, and then you pay taxes on the reduced amount based on your tax rate. Let's say you pay $10,000 a year in mortgage interest and you are in the 25 percent tax bracket. Your taxes are not reduced by $10,000. Your mortgage interest deduction is “worth” $2,500 to you, which is the amount of interest you paid divided by your tax rate.

    The Home Mortgage Interest Deduction

    The higher your tax bracket, the more the home mortgage interest deduction is worth to you because the deduction is based on your tax rate. For an earner in the 25 percent bracket, $10,000 in interest means $2,500 in tax savings, but for someone in the 33 percent bracket, it's a savings of $3,300. The interest on up to $100,000 in loans secured using the home as collateral is also tax deductible, regardless of how the borrowed money is used. Beware, however, that if your total amount of debt exceeds the value of the property, you will not be able to deduct the full amount. If you do not itemize deductions or if you are subject to the Alternative Minimum Tax (AMT), you will not be able to receive any of the benefits of the home mortgage interest tax deduction.

    Investment Properties

    Mortgage interest is deductible when you own investment properties, whether commercial or residential. It is a straight deduction just like any other expense, such as repairs, property taxes or utilities. Interest has no special tax advantage over any other type of expense deduction. If you're planning to buy an income-producing property, keep in mind that mortgage interest rates on loans for investment properties are a bit higher than they are on a loan for a primary residence.

    Second Homes

    If you're lucky enough to own a second home as a vacation property, you can also deduct the mortgage interest. How you take the deduction will depend on whether you use it exclusively as a personal residence or if you make it a rental property, even part time. There are very specific rules, so check with the IRS or a tax professional. It's important to note that if you're using the property as a second personal residence, you are subject to a tax cap on mortgage interest -- 100 percent of the mortgage interest is tax deductible up to $1 million of mortgage debt. If you have two homes, the combined debt cannot exceed that limit if you want to fully deduct the mortgage interest.

    About the Author

    Annabella Gualdoni has written newsletters and reports for corporations and nonprofits since 1994. She is a real estate professional and also teaches subjects including international cooking and travel, dating/relationships and personal finance. Gualdoni has a Bachelor of Arts in international development from University of California, Berkeley, a Master of Arts in international relations from Boston University, and a Juris Doctor from Boston College Law School.

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