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Home Mortgage Loan Interest, Calculating Home Mortgage Interest

How to Deduct Home Mortgage Loan Interest

Home mortgage loan interest can be deducted from your income and significantly reduce your taxes. Mortgage interest on a second home can also be deducted.

Steps

1. Add up all expenses you can itemize as deductions to make sure the total is greater than your standard deduction. The main itemized deductions are state taxes, mortgage interest, home equity loan interest, property taxes and charitable contributions. The standard deduction is $7,200 if married filing jointly, $6,350 if head of household, $4,300 if single and $3,600 if married filing separately. If your total itemized deductions are less than your standard deduction, it's better that you not deduct home mortgage interest.

2. Obtain a Schedule A form to fill in with itemized deductions. The third section of Schedule A is for interest deductions.

3. Write on Schedule A the name of the bank or mortgage company to which you paid mortgage interest, and write the amount you paid during the tax year. The lending institution is required to send you a Form 1098 with this information.

4. Write on Schedule A the name of anyone else you paid interest to for a mortgage loan, and write the amount you paid during the tax year. Individuals who make mortgage loans are not required to send you a Form 1098.

5. Write on Schedule A the name of the lending institution and the amount you paid in the tax year in points to obtain the loan, but only if the loan was to purchase your main home. Points for refinanced loans or for loans for a second home have to be deducted over the life of the loan, not at one time. The institution will send you a Form 1098 listing the points you paid.

6. Continue with the rest of Schedule A.

Tips

You can deduct home mortgage interest on a first home and a second home, but not on any other homes.

Keep good records if you're deducting points over the life of the loan (usually for a refinanced home or second home). When you sell the home or refinance it, you can deduct all the points you have not yet deducted.

If you prepay your January mortgage payment in December, you'll get the deduction in the earlier tax year.

Warnings

To deduct home mortgage interest, you must own the home and you must pay the interest. If you pay the interest but don't own the home, it doesn't count. If you own the home but don't pay the interest, it doesn't count.

If your home mortgage loan was obtained after October 13, 1987, you can deduct the interest on a maximum of $1 million in mortgages, or $500,000 if married filing separately.

If the points were paid from the mortgage (or loan) proceeds and not out of your pocket, you have to deduct them over the life of the loan.

If your mortgage loan was sold by one financial institution to another, as often occurs, the original lender may send you its Form 1098 at the time of the sale and not at the end of the year. Remember that this may be the only notification of the mortgage loan interest paid to that lender, and be sure to include this amount on your Schedule A.

Calculating Home Mortgage Interest

The biggest loan in most individuals' financial lives is a home mortgage. In contrast to a short-term auto loan, a home mortgage loan can run out to 30 years, and the amount borrowed is usually much larger than for an automobile.

Suppose that you recently bought the home of your dreams and qualified for a $250,000 mortgage loan for 30 years at a 6 percent annual interest rate. The loan requires monthly payments, so you divide the annual interest rate by 12 to determine the monthly rate, which is 0.5 percent (or 1/2 of 1 percent) per month. In almost all cases the monthly payments over the life of a mortgage loan are equal and uniform. Assuming uniform payments over the 30-year life of the loan, how much would each of your 360 loan payments be? How do you determine this amount? You probably would assume that the lender's quoted amount is correct ！ and you'd be pretty safe in this assumption. But how can you be sure?

You can use a relatively inexpensive business/financial calculator to quickly determine monthly loan payments. These handy tools have special keys for entering each of the variables of a loan. To determine the monthly payment in this example, pull out your trusty calculator and enter the following numbers for each variable:

• N = number of periods ！ 360 months in this example
• INT = interest rate per period ！ 0.5 percent per month in this example. (These calculators assume that interest is a percentage, so type .5, not .005.)
• PV = present value, or amount borrowed today (the present time) ！ $250,000 in this example
• FV = future value, or principal amount owed after the final monthly loan payment is made ！ $0 in this example. (This means that the loan is fully paid off after the last monthly loan payment; otherwise, you enter the amount of the balloon payment due at the end of the loan.)
• PMT = payment per period based on the four numbers just entered ！ $1,498.88 in this example. (This is the amount you solve for, which appears as a negative number, meaning that you have to pay this amount per month.)

The big advantage of using a business/financial calculator is that you can enter the known numbers (the first four) and then simply hit the button for the unknown number, which appears instantly. Another big advantage is that you can keep these numbers in the calculator and make "what if" changes very quickly. For example, what if the annual interest rate were 4.8 percent? Just reenter the new interest rate (0.4 percent per month) and then call up the new monthly payment amount, which is $1,311.66. The monthly payment difference times 360 payments is $67,396.65 less interest over the life of the loan. It definitely pays to shop around for a lower rate.

If you use the Internet, you can find many Web sites that provide online financial calculators. You can go to one of the popular Web search engines, such as Yahoo or Google, and type "financial calculator" in the search bar. From the list you get, select one that seems to fit your needs. Also, Microsoft Excel and other spreadsheet programs include a financial function for calculating the monthly payment for a mortgage. The old-fashioned method ！ before handheld calculators and personal computers came along ！ was to use printed tables that give the factors for different interest rates and time periods per $1,000. Surprisingly, many people still use these tables, and accounting and finance textbooks still include them. Old habits die hard.

Each mortgage payment is divided between interest for the month and principal amortization, which refers to the reduction of the loan balance. For the first month of our example, the interest amount is $1,250 ($250,000 loan balance x 0.5 percent monthly interest rate = $1,250). Therefore, the first month's principal reduction is only $248.88. Right off, you can see that the loan's principal balance will go down slowly ！ and that a 30-year mortgage loan involves a lot of interest. Lenders provide you with a loan payoff (amortization) schedule. Take a look, although trying to follow down a table of 360 rows of monthly payments is tedious.