Mortgage Interest Deduction: Here’s What Qualifies

If you own a home, one of your first questions may be how it will affect your tax filing. While there have been some changes in recent years, it’s important to know what qualifies as a deduction (and to consult with your tax advisor) so you can get the most out of your tax write-offs.*

What Is the Mortgage Interest Deduction?

A mortgage interest deduction is an itemized tax deduction that allows homeowners to deduct the interest paid on a loan used to buy, build or improve a first or second home. Deductions may vary by state, so consult your tax advisor for questions about these deductions.

Homeowners who purchased a home prior to December 15, 2017, can deduct interest on the first $1,000,000 of mortgage debt ($500,00 if married filing separately). For those who purchased a home after December 15, 2017, a deduction only applies to the first $750,000 of mortgage debt ($375,000 if married filing separately).

How the Mortgage Interest Deduction Works

There are many nuances to the mortgage interest deduction, so keep good records of the interest you’ve paid throughout the year. Here are some things to keep in mind as you evaluate your deductions.

As noted above, you can deduct all the interest you paid on up to $1,000,000 in a mortgage loan, but you can only deduct up to the first $750,000 of home loan debt if you purchased the property after December 15, 2017.

For example, if you bought a home in 2016 and you have $1,000,000 in debt on that home, you can deduct all of your mortgage interest. However, if you purchased a home with the same loan amount in 2022, you can only deduct interest on $750,000 according to the 2017 Tax Cuts and Jobs Act.

There is an exception to the new limit. If you entered into a written contract for a property before December 15, 2017, and closed on the property before April 1, 2018, you are exempt and can deduct your interest on up to $1,000,000 in mortgage debt.

What Qualifies as Mortgage Interest?

The type of mortgage in question (e.g., a first or second mortgage) and the type of property it covers, such as your primary residence versus an investment property, can affect how your mortgage interest deduction works, so you’ll want to know how it relates to your specific case this year. For a complete list of rules and regulations, check out IRS Publication 936. Below is a brief overview of a few common scenarios.

Mortgage Interest on Your Home

To deduct the mortgage interest on your home, you must meet a few qualifications. Your home must be one of the following:

• House
• Apartment
• Condo
• Co-op
• Houseboat
• Mobile home or trailer

The home must also have sleeping, cooking and bathroom facilities. The home itself must be collateral for a mortgage loan.

If you receive a nontaxable housing allowance via the military or because you’ve done ministry work, you can still deduct interest. If you’ve taken out another mortgage to buy out a partner in a divorce as part of a mortgage buyout, you can also deduct the interest on that mortgage.

Mortgage Interest on a Second Home

You can deduct mortgage interest on your second home, but the home must be collateral for a loan.

Mortgage Interest on Rental Property

If you rent out the home and receive rental income on the property, you must be in the house for more than 14 days or more than 10% of the days the home is rented at a fair rental, whichever is longer.

Any Points Paid on Your Mortgage

If you paid points on your mortgage loan, which reduce your loan interest, you can deduct these either all at once or over the course of the loan, but there are requirements:

• The loan must be for your primary home
• Paying discount points must be a regular practice where you live
• The funds for paying the points weren't borrowed
• Interest rates on the points can’t be deducted if they were used to cover non-interest closing costs
• Your down payment should exceed your points, which are calculated as a percentage of the loan

Home Equity Loan Interest

The interest on your home equity loan is only deductible if you use it to make significant repairs to your property. It is not deductible if you use it for another purpose — a large purchase, paying down debt, etc.

Late Payment Charges on Your Mortgage

If you’re late making a mortgage payment and are charged a late fee, this additional cost counts as part of the mortgage interest deduction.

Prepayment Penalties

Some lenders (not Pennymac) charge a prepayment penalty if you pay your loan off early because those lenders want to ensure they get interest income. If you’re charged a prepayment penalty for any reason, you can deduct this as part of your mortgage interest deduction.

What You’re Not Able to Deduct

Not all extra costs associated with a mortgage are deductible. Here’s a look at what doesn’t qualify:

• Mortgage insurance premiums
• Homeowners insurance
• Any interest accrued on a reverse mortgage
• Down payments, deposits or forfeited earnest money
• Title insurance
• Extra principal payments made on your mortgage
• Settlement costs (typically)

How to Claim Your Mortgage Interest Deduction

Are you getting ready to prepare your taxes and want to ensure you’re taking full advantage of your mortgage interest deduction this year? It’s important to ensure all your paperwork is in order and follow these steps to take full advantage of the deduction.

Look Out for Form 1098

Form 1098 shows how much you paid in mortgage interest and any points for the tax year. If you paid $600 or more in mortgage interest, your lender will send you the form and send a copy to the IRS to match up with your return. This form may also show you the amount of interest you’ve paid on your home loan to date.

Can’t find it or unsure if you received it at all? Contact your lender, who can provide you with the mortgage interest you paid for the year.

Itemize Your Taxes

If you want to take advantage of the mortgage interest deduction, you’ll need to itemize your deductions instead of using the standard deduction. Make sure it makes sense to itemize your deductions, as the goal is to take the highest possible deduction available to you.

Instances Where You Can Claim the Mortgage Interest Deduction

There are some scenarios where you can still claim the deduction even if your situation doesn’t exactly fit the standard requirements. Ensure you keep extremely accurate records of all of your property costs throughout the year, as well as the square footage used for spaces like rentals and home offices. Here are some cases that would allow you to still claim the deduction:

• The home was a timeshare
• You rented out part of your home
• You had a home office. Make sure you track the square footage, and you may even be able to claim an additional deduction using Schedule C.
• The home was an apartment co-op
• Your home was under construction
• Your home was destroyed within the applicable tax year
• You and a partner split, and you’re now paying a mortgage on a home you both own

Know Your Tax Advantages with Homeownership

Whether you’re a current homeowner or looking to buy your first home, stay informed about the tax advantages and numerous benefits of homeownership. Talk to your tax advisor or visit the IRS website.

Ready to purchase or refinance and want to know your home loan options? Contact a Pennymac Loan Expert now for your free mortgage consultation or apply online to get started on your pre-qualification.

*Consult a tax adviser for further information regarding the deductibility of interest and charges.

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