Using Mortgage Interest as an Itemized Deduction
What is mortgage interest? It is any interest you pay on a
secured loan when you bought your first or second home. The
loans include the mortgage to buy your home, a second mortgage,
a line of credit or a home equity loan. The loan must be secured
debt or it will be considered a personal loan and the interest
is not deductible.
For the average consumer who has managed to acquire credit card
debt, car loans, and various other small debts, is the mortgage
interest, especially with an interest only loan an answer to
mortgage interest deductions and the elimination of
non-deductible interest?
What options does the average consumer have in accommodating the
tax need in relation to the housing need? What about the
interest only loan option on a new house mortgage? Today's
housing and mortgage market has seen a tremendous growth in
mortgage packages, variety and amount. The mortgage interest
deductible on the interest only loan option, once thought to
have gone the way of the Edsel automobile, is back today and in
use by the masses. The mortgage market has seen an unbelievable
increase in the interest only loans from just a mere sliver of
the market a few years ago, to around 25% of the market share
today. That's huge growth, especially when you talk less than
five years to experience that growth.
What benefit does the mortgage interest (especially the interest
only loan) bring to the table, and does this benefit the
homeowner as a taxpayer? This is one question the mortgage
lender probably won't be able to answer for you, and one you
probably won't think to ask. But you should, because it's one
question that can make a difference to you and to your federal
tax return and the amount of the mortgage interest that will
actually provide you with a federal income tax deduction. A
mortgage interest deduction is one of the best financial reasons
to purchase a home. Who gets the deduction? You do, if you are
the primary borrower, legally obligated to pay the debt and
actually make the payments. If you are married and both of you
signed the loan then both of you are the primary borrowers.
The interest only loan and the amount of interest you can deduct
on your income tax return are one and the same if your income
levels are low enough; the concern for the average consumer is
the total dollar value they get to take off their tax return.
Quite often, the deductions for the consumer aren't enough to
contribute to the bottom line, because the income level the
percentage of deductible interest is calculated on is simply too
high. Higher dollar amounts in interest will usually mean a
greater possibility of a greater deduction. There can be limits
to the tax deduction. Your tax deduction is limited if all
mortgages on your home are either more than the fair market
value of your home or more than one million dollars ($500,000 if
married and filing separately)
The greater deduction would be the only advantage to the
interest only loan as far as the taxpayer is concerned, unless
of course, they use the money saved from the interest only loan
to fund a 401k, an IRA, or an MSA (that's a topic for a
completely different paper). The mortgage interest and
especially the interest only loan is sold to the consumer as a
way to afford more house, pay off credit card debt, or provide a
means to fund a savings of some kind, and if that's true, it can
be used for that purpose. And if you're considering paying off
those high interest credit cards, the mortgage interest you're
charged on the interest only loan is fully tax deductible, while
the credit cards are not; a word of caution, however, make sure
you don't turn around and use those credit cards again, putting
yourself right back where you started from, just with a bigger
interest payment and less house equity.
Why has the market experienced such growth? It's not totally
related to the income tax benefit; the home mortgages of today
satisfy a common desire for the consumer: instant gratification
of bigger and better. Such is the case when it's time to make
those needed repairs, or house expansion. A second mortgage
makes it possible to retain the same monthly mortgage payment,
and still pull a lot of equity out of your home. This may sound
like the ultimate solution, but is it really? It also adds to
the amount of interest an individual can deduct at the end of
the year; and if income levels are growing, the interest expense
must grow in order to keep up. Now, this is a somewhat skewed
way of looking at the benefit of a mortgage, but it figures
right into the same scheme as the elimination of credit card
debt and saving for 401(k) s as a valid reason to borrow money
against your home. Remember that your home mortgage must be a
secured loan from your main home or second home. No deduction
can be made for a mortgage from a third home, fourth home and so
on. The mortgage and the resulting interest are great tools,
when used by the right people, in the right situation. For the
average consumer and long-term homeowner, unless you think a
better deduction on your tax return is worth the forfeiture of
equity in your home, you'd better think twice before
re-financing with a second mortgage that generates more
interest, but less equity.