How to Calculate a Mortgage Interest Deduction
The Internal Revenue Service (IRS) allows taxpayers to deduct the amount of mortgage interest they paid over the tax year, provided that the taxpayer itemizes their deductions. IRS Publication 936 explains that this interest may have been paid on a first or second home and have been affiliated with a first mortgage, equity line of credit or home equity loan.
Form 1098 and Yearly Mortgage Interest Amounts
Taxpayers paying more than $600 per year in mortgage interest receive a Form 1098 from the lender at the beginning of the year. The law requires that a copy of this form be provided to the IRS.
Provided you qualify to take the deduction, which is explained below, the amount listed on the form is fully deductible. Interest reported on Form 1098 is reported on line 10 of Schedule A of Form 1040.
Calculating Mortgage Interest Amounts
In instances when mortgage interest payments are not reported on Form 1098 - for example, when you borrow money from an individual, such as the home's seller, and not an institution- you might need to calculate the amount of interest you paid. There is an 8-step process to calculation and reporting this amount.
Because most taxpayers pay less interest each month over the life of their loan, the amount of deductible interest payments differs each year. The calculation explanation and example contained below is based on your trying to calculate interest payments for the first year of the loan. To calculate how much you paid in interest in a given year, you will need to know the mortgage's exact loan amount as of the beginning of each taxable year.
Step 1: Gather Necessary Information
To calculate the amount of interest on a mortgage that you paid in a given year you must know the loan amount, length of the loan, and the loan's interest rate. Using an example of a $75,000, 30-year mortgage with an interest rate of 6%, when calculated using the formula to calculate mortgage payments, this comes to a monthly payment of $449.66.
Step 2: Determine Monthly Interest Rate
To determine the monthly interest rate for the loan, divide the interest rate (in this example, 6%) by 12, which represents the number of months in a year: .06/12 = .005.
Step 3: Determine How Much Interest You Pay in the First Month
To identify how much interest you pay in the first month of the year, multiply the monthly interest rate for the loan by the total loan amount: .005 x $75,000.
In this example, for the first month of the first year of the mortgage you paid $375 in interest.
Step 4: Calculate How Much You Pay Toward Principal in the First Month
Subtract the amount of interest you paid from the full monthly payment amount to calculate how much you paid in principal in the first month of the first year of the mortgage: $449.66 - $375 = $74.66.
Step 5: Determine New Loan Balance
Subtract the amount that you paid toward principal in the first month of the first year of the mortgage to determine the remaining balance on the mortgage: $75,000 - $74.66 = $74,925.34.
Step 6: Repeat to Determine Each Month's Interest Payment
Starting with the new loan balance as calculated in Step 5, repeat steps 2-4 for subsequent months of the year.
Step 7: Total Your Monthly Interest Payments
Add together all your interest payments made throughout the year to determine how much you paid over the year. This is your deductible amount.
Step 8: Report the Amount of Paid Interest
The amount of interest you paid over the year, as calculated, is reported on line 11 of Schedule A, which must also contain the name, address, and taxpayer identification number of the individual to whom interest was paid.
Calculators to Help
Online calculators tell you how much you can save on your federal income taxes. Available calculators include:
- Money-Zine: To use this calculator, you must provide the loan term in months, your federal tax bracket, the loan amount, and the loan's annual interest rate. It generates the total interest that you can deduct and the entire tax benefit over the life of the mortgage.
- Bankrate: This website's calculator requires you to input the mortgage amount, loan term, federal and state tax rates, and the loan's interest rate. It then provides you with the amount of interest you paid each year of the loan.
Limitations on Deductions
The IRS limits the amount of deduction for mortgage interest payments that can be taken:
- Mortgage to purchase a home: This includes any mortgage taken after 1987 to purchase, build or improve a home. The maximum loan amount for this type of loan cannot exceed $1 million or $500,000 for married couples filing separately.
- Home equity mortgage: The limit on deducting interest paid on a home equity loan is the lesser of the total of the home's fair market value that was reduced by the amount of home acquisition debt or $100,000 for married couples filing jointly or $50,000 for married couples filing separately.
Eligibility to Deduct
According to IRS Publication 936, mortgage interest payments can be deducted from tax returns if:
- The taxpayer files a Schedule A for Form 1040 and
- The mortgage is on a qualified home in which the taxpayer has a secured debt and
- Both the taxpayer and lender intend the mortgage to be repaid.
A qualified home is the taxpayer's first or second home, including a boat, house trailer, mobile home, and condominium. Interest on a main home used for more than one purpose, such as for a home office, can only be deducted for the amount applicable to the residential use of the home. If a second home is rented out, the taxpayer must use the home for more than 14 days or 10% of the days that the home is rented for it to qualify.
Deducting Your Interest Payments
Using either the form sent to you by your lender or the calculation above, you may be able to deduct the full amount of your yearly mortgage interest payments. Doing so can save you money on your taxes. For more information, speak to a tax professional.