Mortgage Amount: Enter the total amount of the mortgage. If you are folding closing costs and fees into the mortgage, remember to include those in the total.
Term: Enter the number of years the term of the mortgage will last. Usually the mortgage term is either 15 or 30 years, as in "a 15-year mortgage" or "a 30-year mortgage." Ten or 20-year mortgages are rarer.
Interest Rate: Enter the mortgage's quoted interest rate as a percentage. If you have not actually applied for a mortgage yet, you can usually find out the interest rate you would qualify for by contacting a mortgage lender for a quick rate quote, without any obligation.
Federal Tax Rate: Enter your tax bracket rate as a percentage. This is also often called your "marginal tax rate."
State Tax Rate: Enter your state tax rate as a percentage.
Points: Enter the points you are paying on your mortgage. "Points" refers to money you pay upfront on the mortgage to cut down on the interest you'll eventually have to pay. This amount is tax-deductible.
Mortgage Interest Tax Savings: A Deduction, Not a Credit
The mortgage interest tax deduction works like other tax deductions. With a tax deduction, a certain amount of your income is not taxed. This can save you thousands of dollars in taxes a year. However, it is important to remember that a deduction is not a credit. A tax credit simply gives you a lump sum of money off the amount you pay in taxes, period. A tax credit does not care what you are paying in taxes already. It's like a giant coupon for your taxes. If you are going to pay $10,000 in taxes, a $2000 credit will mean you only have to pay $8,0000 in taxes. A deduction, meanwhile, is much less generous, and much less straightforward. If you have $50,000 in taxable income, and have to pay 20% of it, or $10,000, a $2,000 tax deduction will only mean that you save 20% of $2,000, or $400. That is, with the $2,000 tax deduction on a $50,000 income, you are paying taxes on $48,000 of income rather than $50,000.
Unfortunately, many people misunderstand the mortgage interest tax deduction to think that it makes buying a house a virtual tax savings bonanza. They're confusing a tax deduction with a tax credit. In reality, the tax deduction only saves you a fraction of what you are paying in mortgage interest. If you are in the high 35% tax bracket, you are only getting back up to 35% of your mortgage interest. The other 65% is still coming straight out of your pocket. Of course, that still makes homeownership much more affordable. But in itself it's no reason to pay more interest on your mortgage than you have to, or to buy a house rather than rent.
The Mortgage Interest Tax Deduction in the Future
In 2005, a president-appointed advisory committee issued a report recommending sweeping changes to the system of tax deductions for mortgage interest. The committee recommended limiting the availability of the deduction for properties that were much more expensive than other properties in the local market. The biggest concern was that the mortgage interest tax deduction was disproportionately benefiting the wealthy and people who simply overpaid for their houses.
In the late 1990s and early 2000s, a large market of "mega-houses" and "McMansions" had sprung up. These houses, costing anywhere from 50% to 300% more than the average house in their local markets, were made possible largely by the mortgage interest tax deduction. In essence, the federal government has been subsidizing the purchase of ever more lavish houses. It was argued that the tax deduction was primarily transferring wealth from average taxpayers to the construction and real estate industries. Even worse, the resources needed to construct, maintain, and above all, heat and/or air-condition these enormous houses was an environmental headache and an energy conservationist's nightmare.
The commission recommended denying the mortgage interest tax deduction to expensive houses and replacing the tax deduction with a tax credit, which might even be made available to renters as well.
The current presidential administration seems to have shelved the report created by its own committee. For now it seems that no change in the mortgage interest tax deduction is likely. Still, if you are considering buying a McMansion or even just a stylish townhouse, it's worth remembering that the mortgage interest tax deduction may not always be available to subsidize your expensive house.