How Much Are You Really Saving with the Mortgage Interest Deduction?

by Kevin on July 12, 2010

One of the most commonly touted benefits of being a home owner is the ability to deduct mortgage interest from your taxes. This benefit is one reason why many people elect to continue to invest in their 401k or IRA before paying down the mortgage faster. Why lose that tax deduction?

I think for many Americans this is flawed logic. Rather than running through the numbers in paragraph form, I’ve put everything in a table below to hopefully ease understanding.

Does Mortgage Interest Save on Taxes?

The table below shows how much interest you would pay over the first full year of having a mortgage. I’ve shown differing home and down payment amounts. This obviously creates different mortgage sizes. The larger the mortgage the more interest you pay each year.

We’ll look at each scenario ($100,000, $150,000, and $200,000 home price) separately.

I’ve only calculated the first year of interest because your first year will be the most interest you pay over the life of the loan. As you pay down the mortgage the amount of interest in each payment becomes less and less. For the sake of simplicity I am assuming you bought the house on the first day of the year so you get the full tax benefit for the year.

Home Price$100,000$150,000$200,000
20% Down Payment$20,000$30,000$40,000
Mortgage Amount$80,000$120,000$160,000
30-Year Mortgage Interest Rate5.0%5.0%5.0%
Year 1 Total Interest3,973.175,959.797,946.39
Single Filer Additional Deductions Needed (or Excess Deductions)1,726.83(259.79)(2,246.39)
Single Filer Mortgage-Only Tax Benefit (assuming 25% Tax Bracket)N/A64.95$561.60
Married Filing Joint Additional Deductions Needed7,426.835,440.213,453.61
Married Filer Mortgage-Only Tax Benefit (assuming 25% Tax Bracket)N/AN/AN/A

Note: Standard deduction for single filers is $5,700; Married filing jointly is $11,400

$100,000 Home Scenario

With the first home you end up with a pretty small mortgage of $80,000. What we find here might surprise some of you. The mortgage alone will not provide any tax benefit to you as either a single or married filing joint filer.

In the first year you’ll pay $3,973.17. For single filers the standard deduction is $5,700. You would need an additional $1,726.83 in other deductions before you start getting any tax benefits. The mortgage covers about 70% of your standard deduction. In other words, if this was your only deduction you would be better off taxing what the government gives all single filers.

Granted you could certainly manage to exceed the standard deduction amount through charitable contributions or employer related deductions like 401k investments or Health Savings Account contributions.

But with just the mortgage? You’d be better off not itemizing deductions and taking the standard deduction.

For married filers the news is even worse. You would need an additional $7,426.83 in deductions before you would reach the standard deduction of $11,400. Your mortgage interest covers only 35% of the standard deduction.

$150,000 Home Scenario

Moving up to a larger mortgage would surely provide some sort of tax benefit, right?

Technically, yes, but again there are some surprising results.

The situation is the same for married filers. The mortgage only covers 52% of the standard deduction, leaving you over $5,400 in other deductions needed to get any tax benefit from your mortgage.

For single filers you do get a little bit of benefit. That $5,959.79 in mortgage interest exceeds the standard deduction. Woo hoo! Time to celebrate, right?!

Errr… no, not really. You would reduce your taxable income by $260. In the 25% bracket that would save you a whopping $64.95.

In other words you spent $6,000 to get $65 in tax benefit. Ouch.

$200,000 Home Scenario

Surely in a nice $200,000 home our poor married folks will get some sort of benefit, right?

Unfortunately, no. That really took me by surprise. The interest you pay only covers 70% of the standard deduction.

For our single filers the news is yet again getting better. You would pay $7,946.39 in interest and reduce your out of pocket tax hit by $561.60.

But again you’re paying quite the hefty amount of interest to save less than $600 in taxes. You’ve had to assume $160,000 in debt while putting down $40,000 into an illiquid asset.

Other Mortgage Factors to Consider

Of course the amount of tax break you get just off your mortgage shouldn’t be the only thing you consider when deciding to pay down your mortgage or not. In my next post we’ll cover some other factors you will want to consider.

I’ll also show you what size mortgage you would need at a 5% interest rate to exceed the standard deduction for our poor married home owners.

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July 25, 2010 at 4:42 pm

{ 9 comments… read them below or add one }

Darwin's Money July 12, 2010 at 10:10 pm

It’s great that you broke it down this way. 99% of people out there wouldn’t look at it this way. Especially for the lower borrowed amounts, there’s not the benefit they may have thought when factoring in std deduction.

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Kevin July 13, 2010 at 9:06 pm

Thanks. Obviously if you have a huge mortgage and a huge interest rate then the deduction comes into play. I’ll have something up on Thursday about that.

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Golfing Girl July 13, 2010 at 9:35 am

Thanks for running those numbers. I can’t wait to post a link on the MSN Money Message boards–there are a lot of “you’re stupid for prepaying your mortgage” folks and “you’ll get rich from deducting the interest on your home so mortgage away!” types. :)

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Kevin July 13, 2010 at 9:06 pm

Ha! I saw some visitors coming in from that. Appreciate the link. We’ll see on Thursday how much your mortgage needs to be, plus some other factors to consider.

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Dee July 14, 2010 at 12:53 am

Thanks for the break down. I think you framed it in a simple enough way that people can see that the deduction isn’t always as great as some make it out to be.

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Petunia July 14, 2010 at 11:04 am

I followed the link to your blog from MSN Money. Like the blog, glad Golfing Girl posted the link. I’m always looking for a new blog to follow.

I have to say, I’ve been posting on MSN Money for years and I’ve never once seen anyone suggest one can get rich deducting mortgage interest. I have seen many times the suggestion that if you can borrow money at 5% and invest it earning 10%, that is very good for your bottom line.

Personally, I think the key to most things in life is balance. So I prepay my mortgage some, save some, and invest some.

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Kym September 29, 2010 at 5:44 pm

If only I lived somewhere with houses so cheap! Houses out here in SoCal don’t even start at 200k. For me, the main reason I would be interested in taking the deduction on the interest would be to better compare it to my rent – if the deduction means that my $4500 monthly mortgage payment really turns out to be more like $3000 after deductions, well that makes quite a difference in how affordable the place is. Trying to get into any house here without large gifts of money is pretty much impossible until you’ve had a decade or so to save, so the deduction might mean being able to buy in 4 more years instead of the 6 years it will take me right now.

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Jerrod Donahoe July 4, 2011 at 9:37 pm

Thank you for this publish, I’ve been always on the lookout for this useful articels all over but could not find full information supplied here. thank you. and I will simply reference a few of you words .

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Bill January 28, 2013 at 6:54 pm

Wow, I’ve never seen this broken down so simply. This article has really changed the way I will look at investing in Real Estate in the future. I would still rather own than rent but this article really makes me look at it in an entirely different view and not just accept the adage that owning and paying interest allows you to reduce your tax liability. I can see where that is not always the case and has to be evaluated. I’m going to start working hard to pay off my mortgage based on this and take the standard deduction. Great article Kevin.

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