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Are Home Interest Loans Deductible From Taxes?

Updated for Tax Year 2014


OVERVIEW

The federal government encourages you to purchase a home by allowing for the deduction of mortgage interest. Find out more about this deduction and how you can benefit from it.


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Introduction

The federal government encourages you to purchase a home by allowing for the deduction of mortgage interest. Although other requirements exist, only the interest you actually pay during the year is eligible for a deduction. If you make a late mortgage payment in the following tax year, you must wait until that year to claim the deduction.

Collateral in your home

It's likely that your mortgage lender has a security interest in your home as collateral for repayment of the loan. This security interest generally allows the bank to remain on the title to your home. As long as the mortgage document you sign includes this type of security interest, then you may be eligible to deduct your interest payments.

When checking your mortgage document, it may either expressly state this or will provide that in the event you default on mortgage payments, the bank can foreclose on your home and apply all sale proceeds to the outstanding mortgage balance. However, if you use a credit card to subsidize the purchase of your home, these interest payments are not deductible since the credit card company doesn't have any security interest in your home.

Two qualified homes

The IRS limits the number of homes eligible for the deduction to your main home that you principally reside in plus one other home that you own. The tax law does not grant you discretion in choosing which residence to treat as the main home. This must always be the place where you ordinarily live for a majority of the year.

However, you can choose any second home to qualify for the deduction. Whichever second home you choose is only binding for the current tax year. Next year, you can deduct the mortgage interest on a different second home if it provides greater tax savings.

Deduction limitations

To prevent taxpayers from claiming a deduction for luxurious homes, the law limits the deduction to the interest that you pay on up to $1 million in total mortgage balances. This $1 million limitation applies to the total of both mortgages.

For example, if you owe $600,000 on your main home and $800,000 on a vacation home, you cannot deduct the interest you pay that relates to the excess $400,000. In some cases, the excess interest may qualify for a deduction if it relates to a home equity loan.

Home equity loan interest

If you take out a home equity loan, your interest payments may qualify for a deduction in addition to your mortgage interest. To qualify, you must have obtained the loan after Oct 13, 1987 and it must also be secured by your home.

For tax purposes, only the balance of the loan that is the smaller of $100,000 or your equity in the home qualifies for the interest deduction. Your equity is equal to the amount you could sell the home for minus the amount you still owe on the mortgage.

Reporting the Deduction

The deductions for home equity and mortgage interest are only available to taxpayers who are eligible to itemize deductions on a Schedule A attachment to their Form 1040. Eligibility to itemize requires that your total itemized deductions, including home interest, be greater than the standard deduction amount.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.

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