Finance Friday: How Your Mortgage Can Save You Even More at Tax Time

What’s So Great About a Mortgage?

Well, a lot of things. Having a mortgage means you’re building equity in a home you may enjoy for years, a home where you can raise a family, make improvements if you like, and really home! On a more practical note, mortgage interest deductions are a great way to reduce your tax payments, and who doesn't’ want to pay fewer taxes? Introduced as an incentive for people to own their own homes, these perks have become a staple for the modern American homeowner.

Mortgage interest deductions are an effective way to reduce your tax payments. You can subtract the interest you pay on your home loan from your taxable income. One house just isn’t enough? Mortgage interest deductions are allowed for a maximum of two homes. And if you're lucky enough to own more than two homes, you can change which of these is designated as your secondary residence. (Mortgage interest deductions can also be deducted for properties that you rent out. However, in order for the rental property to count as a second home, you need to spend more than 14 days in the home every year, or more than 10 percent of the days you rent it out.)

Mortgage interest deductions aren’t unlimited. Generally, you are eligible for a mortgage interest deduction if your loan falls into any of these categories.

  • You took out a mortgage that totaled less than $1 million (or $500,000 if you are married and wish to file separately) throughout the year to buy, improve, or build your main home

  • You took out a home equity line of credit and used the funds to the tune of $100,000 ($50,000 if you are married and wish to file separately) or less.

Who Uses It? And How?

You might guess most homeowners benefit from this deduction. However, that’s not the case. A 2013 report by the Pew Charitable Trusts shows that the popularity and benefits of mortgage tax deductions are unevenly distributed across the country. Instead of being used evenly, these perks are more popular in parts of the country where people have relatively high incomes (which places them in higher tax brackets and allows for higher deductions).

In areas where income and property values are low, the benefits are less noticeable. For instance, within Louisiana and Mississippi, less than 17 percent of the people filing for tax included this deduction. However, in states along the east and west coasts, like Maryland, Connecticut, Georgia, New Jersey, New York, Oregon, California, and Washington, the percentages of people using the deduction were higher than national averages.

Deductions also vary within states, with homeowners in densely populated areas more likely to benefit. For example, within Austin, Texas, the claim rate was about four times that of people living in Odessa, Texas.

Why the Difference?

One of the major reasons why current mortgage interest deduction usage rates appear skewed towards high-income owners is how they’re calculated. Under current tax laws, the deduction is determined in part by the homeowner’s top tax rate. Because of this, people with incomes of $100,000 and above enjoy bigger deductions.

Mortgage interest deductions also appear to be affected by the local housing market. For instance, homeowners who live in dense urban metropolitan areas like San Francisco benefit from high tax breaks. And since the market experiences frequent turnovers, owners also get to enjoy higher deductions than they would in a more stable market.

Should You Feel Guilty About Taking the Deduction?

That's up to you, but we think you should take the deduction and run. According to a PEW report from 2011, mortgage interest deductions reportedly cost the U.S. Treasury more than $73 billion in lost revenue. This figure is only slightly higher than the $68 billion the treasury lost in 2012.

Since the publication of the report, there have been several attempts to adjust or overhaul to reduce the federal deficit. That being said, these deductions are still in place, and you should enjoy them as a benefit of owning your home. The deduction is legal, and you're contributing to the economy and your town by spending on your home and keeping it looking good. Go, you!

Will the Deductions Change in the Future?

They might, but not right this second. And the possibility of them being eliminated entirely is very slim. Current suggestions include replacing mortgage deductions with a credit, capping itemized deductions, or limiting deductions to only first homes.

Some economists propose reducing the upper limit on mortgage interest deductions to $700,000 (from $1 million) and then dropping this value further by $25,000 every year. At this rate, the subsidy would be gradually phased out over a three-decade period. (That would be the entire length of a 30-year mortgage if you got one today.)

To even out benefits across different income tax brackets, deductions could also be capped at 28 percent. This approach would give low-income taxpayers a better break, maintain the current benefits enjoyed by the middle class, and only gradually reduce the subsidy of high-income earners. In the same vein, the value of this deduction could be reduced by a percentage each year, so that it ends in 28 years.

Of course, all these options are mere conjecture at this point. So you might as well take full advantage of the current mortgage deductions and enjoy your home!

Other deductions to consider: