Calculating the Home Mortgage Interest Deduction (HMID)

The home mortgage interest deduction (HMID) allows homeowners who itemize on their tax returns to deduct mortgage interest paid on up to $750,000 worth of their loan principal.

The HMID is one of the most cherished American tax breaks. Realtors, homeowners, would-be homeowners, and even tax accountants tout its value, but the myth no longer lives up to the reality for many homeowners.

Most Homeowners Get Nothing

The Tax Cuts and Jobs Act (TCJA) passed in 2017 reduced the maximum mortgage principal eligible for deductible interest to $750,000 for new loans, down from $1 million. Homeowners can deduct the interest paid on up to $750,000 in mortgage debt.

The TCJA also nearly doubled the standard tax deduction while eliminating the personal exemption from the tax code. Moreover, the act eliminated a number of tax deductions that could add up to a tidy sum when combined with the mortgage deduction.

All these changes made it unnecessary for most taxpayers to itemize. The standard deduction is a better deal.

An estimated 135.2 million taxpayers were expected to opt for the standard deduction in the first year following the implementation of the TCJA. Only 20.4 million were expected to itemize, and 16.46 million of those would claim the mortgage interest deduction.

The mortgage interest tax deduction is perhaps the most misunderstood aspect of homeownership. Many prospective homeowners are sold on the benefits before they even examine the math.

Underlying the myth are two big misconceptions: Every homeowner gets a tax break and every dollar paid in mortgage interest results in a dollar-for-dollar reduction in income tax liability.

The Mortgage Interest Deduction

Misconception 1: You Will Get a Tax Break

Despite the hype, the overwhelming majority of homeowners receive no tax break at all from the mortgage interest tax deduction. They must itemize their deductions when determining their income tax liability to qualify for the deduction and claim it.

Itemizing provides an opportunity to account for specific expenses, including mortgage interest, property taxes, and partial medical expenses. Mortgage interest is in many cases the largest of these expenses that a taxpayer pays, so deducting it is often cited as a financial incentive to buy a home.

But the reality is that passage of the TCJA means that itemizing deductions no longer makes sense for most people. Both the standard deduction and itemized deductions are subtracted from the total of a taxpayer’s income and they’re taxed on the remaining balance. The standard deduction typically far exceeds the total of most taxpayers’ itemized deductions. They would therefore be paying tax on more income than necessary if they itemized. It’s not possible to itemize and claim the standard deduction, too.

Taxpayers who don’t have itemized deductions that add up to more than the standard deduction amounts derive no tax benefit from paying interest on their mortgages.

Misconception 2: It Will Be a Hefty Deduction

The amount of the deduction is a fraction of the amount of interest paid on the mortgage even for homeowners who itemize their deductions and who qualify for the mortgage interest tax deduction.

A little number crunching is required to fully understand the situation. This is a deduction, not a tax credit. You don’t get a $1 tax break for every dollar spent as you would with a credit.

The mortgage interest deduction merely reduces the amount of your total income that is subject to taxes based on your tax bracket. You get pennies on the dollar.

Example of Mortgage Deduction

A taxpayer spending $12,000 on mortgage interest and paying taxes at an income tax rate of 24% would be permitted to exclude $12,000 from income tax liability. This would result in a savings of $2,880, or 24% of $12,000.

The homeowner has paid $12,000 to the bank in interest to get less than a fourth of that amount excluded from taxation. Spending $12,000 to reduce the amount of money you will pay in taxes by $2,880 simply makes no sense. Worse yet, an honest assessment of the actual bottom-line savings should factor out the value of the standard deduction.

Using our $12,000 mortgage interest example, let’s say a married couple in the 24% tax bracket would be able to claim a $30,000 standard deduction, which is worth $7,200 in reduced tax payments. The mortgage deduction would come to just $2,880 if the couple itemized their deductions on Schedule A.

The couple would get the tax reduction value of the standard deduction even if they don’t have a mortgage. The difference between the two (the standard deduction and the tax break gained by paying $12,000 in real dollars to the bank in mortgage interest) would be a loss. Taking the standard deduction would be far better than itemizing just to claim the mortgage interest tax deduction.

Even taxpayers in higher tax brackets would get no benefit unless they have other high-dollar-value deductions to itemize. A taxpayer spending $12,000 on mortgage interest and paying taxes at an individual income tax rate of 35% would receive only a $4,200 tax deduction. That’s less than what the taxpayer would receive from taking the standard deduction.

A Better Way

Of course, you would be far better off paying cash for your new home rather than spending large amounts of money on interest for up to 30 years. A cash purchase would save you tens of thousands of dollars in interest.

There’s always the argument that you could make more money by paying the interest and investing the rest of your money in the stock market. It seems like a great strategy when the market is going up, but the prognosticators giving that advice are nowhere to be seen when the stock market drops by 40%, home values fall by 40%, and their investment advice leaves homeowners owing more on their mortgages than their homes are worth.

No investment out there will guarantee better returns than the amount you would save by avoiding interest payments altogether so the conservative choice is clear. Avoid making interest payments if you can. Pay off the house quickly if you cannot.

The Bottom Line

The home mortgage deduction can be beneficial if it works in your favor, but many homeowners don’t receive the tax benefit based on their financial situation. Take a look at what will work best for you before buying a home. It might make more sense to put down more cash and avoid as many interest payments as you can.