In the US, we’re lucky to have the option to deduct mortgage interest expense from our income, which can help reduce our tax bill. The amount you can deduct depends on your income, but I’ll explain more about that later.
In the past, you could deduct interest on up to $1 million in mortgage debt, but that changed in 2017 with the Tax Cut & Jobs Act. Now, the limit is $750,000. While this might be a bummer for those with big mortgages, it’s still better than nothing. In places like Canada, Australia, Asia, and Europe, there’s no such benefit. But hey, at least they have affordable healthcare!
Now, let’s talk about how much you can save with this deduction. If you’re in the top tax bracket, you get 37 cents back for every dollar in interest you pay on your mortgage. If you also pay state income tax, your marginal tax rate could reach 50% on your last dollar of income earned. The great thing about the mortgage interest deduction is that it applies to your marginal income, which means it applies to your highest marginal tax rate.
Even if your mortgage isn’t big enough to take full advantage of the maximum mortgage tax deduction, that’s okay. Use as much of the mortgage interest tax deduction that you’re eligible for to save money on your taxes.
For those in the 12% Federal tax bracket or below, a mortgage tax deduction isn’t very beneficial. You’d need a huge mortgage at a 12% Federal marginal tax rate to see any benefits because the standard deduction is $12,000 for singles and $24,000 for married couples.
When you’re in the 24% marginal tax bracket, that’s when owning a home starts to make more sense, as long as you follow the 30/30 rule for home buying.
Now, let’s look at a couple of examples.
Example #1: Let’s say you earned $518,400 in 2020 as a single tax filer. Your income from $207,351 to $518,400 is taxed at a 35% Federal Tax rate. If you paid $50,000 in mortgage interest for 2020, you get to reduce your taxable income by $50,000 from $518,400 to $468,400. As a result, you’re paying $17,500 less in Federal taxes!
Example #2: Let’s say you earned $136,000 in 2020. Roughly $50,000 of your income will be taxed at a 24% federal tax rate. If you managed to pay $50,000 of mortgage interest for 2020, your taxable income is only $86,000. As a result, you’re paying $12,000 less in Federal taxes.
In conclusion, owning a home with a mortgage is more beneficial for those who have higher incomes. There’s also an income threshold where once breached, every $100 over minimizes your mortgage interest deduction. That level is roughly $200,000 per individual and $400,000 per couple for 2021.
The ideal income to earn for homeowners is around $250,000 for singles and $300,000 for couples. Earning more than $250,000-$300,000 doesn’t do much to improve happiness. It might make you mad due to higher taxes.
The ideal mortgage amount for the ideal income is therefore $750,000, which equals 3X a household income of $250,000. This also fits perfectly with my 30/30/3 rule for home buying.
The US government is pro homeownership, therefore take advantage of the benefits. You get $250,000 in tax-free profits if you sell your house and are single, double the amount if you are married.
Single filers get a standard deduction of $12,400 for 2020 ($24,800 for married filers). The government allows you to automatically choose between standardized or itemized, whichever is greater. Given we are talking about $750,000 dollar mortgages as the ideal mortgage amount, itemized deductions will always be chosen.
Lastly, if you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, consider real estate crowdsourcing. It allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.
In summary, the higher your marginal income tax rate and income, the greater the mortgage tax deduction benefit. However, after about a $200,000 individual income, the mortgage tax deduction benefit begins to phase out due to AMT.
