Calculating the Home Mortgage Interest Deduction (HMID)

The home mortgage interest deduction (HMID) is one of the most cherished American tax breaks. Realtors, homeowners, would-be homeowners, and even tax accountants tout its value. In truth, the myth is often better than reality.

Most Homeowners Now Get Nothing

The Tax Cuts and Jobs Act (TCJA) passed in 2017 changed everything. It reduced the maximum mortgage principal eligible for the deductible interest to $750,000 (from $1 million) for new loans (which means homeowners can deduct the interest paid on up to $750,000 in mortgage debt). But it also nearly doubled standard deductions, making it unnecessary for many taxpayers to itemize.

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

The mortgage interest tax deduction is perhaps the most misunderstood aspect of homeownership. It has taken on near-mythical status to the point where many would-be homeowners are sold on the benefits before they even examine the math to determine their eligibility.

Underlying the myth are two primary misconceptions: The first is that every homeowner gets a tax break, and the second is that every dollar paid in mortgage interest results in a dollar-for-dollar reduction in income tax liability.

The Mortgage Interest Deduction Now

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. Keep in mind that to even qualify for the deduction, homeowners must itemize their deductions when determining their income tax liability. Itemizing provides an opportunity to account for specific expenses, including mortgage interest, property taxes, and partial medical expenses. As mortgage interest is often the largest of these expenses that a taxpayer pays, deducting it is often cited as a financial incentive to buy a home.

Once again, while an attractive idea in theory, the reality is that passage of the TCJA means that itemizing deductions no longer makes sense for most people. For taxpayers who are single or married but filing separately, the standard deduction is $12,550 in 2021 (increasing to $12,950 in 2022). For heads of households, it is $18,800 in 2021 (increasing to $19,400 in 2022). For married couples filing jointly, the standard deduction is $25,100 in 2021 (increasing to $25,900 in 2022).

Misconception 2: It Will Be a Hefty Deduction

Even for homeowners who itemize their taxes and qualify for the mortgage interest tax deduction, the amount of the deduction is a mere fraction of the amount of interest paid on the mortgage. Once again, a little number crunching is required to fully comprehend the situation because the deduction is not a tax credit.

You don’t get a $1 tax break for every dollar spent; you get pennies on the dollar. Unlike a credit—which provides a dollar-for-dollar reduction on actual tax amounts owed—the mortgage interest deduction reduces the amount of total income subject to tax based on the taxpayer’s tax bracket.

For a simplified example, a taxpayer spending $12,000 on mortgage interest and paying taxes at an individual income tax rate of 24% would be permitted to exclude $12,000 from income tax liability, resulting in a savings of $2,880. In effect, the homeowner 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. The table below provides a comparison.

Using our $12,000 mortgage interest example, a married couple in the 24% tax bracket would get a $25,100 standard deduction in 2021, which is worth $6,024 in reduced tax payments. If the couple itemized their deductions on Schedule A, the mortgage deduction would come to $2,880.

The couple would get the tax reduction value of the standard deduction even if they do not have a mortgage. The difference between the two—the tax break gained by paying $12,000 in real dollars to the bank in mortgage interest—would be a loss of $3,144. Taking the standard deduction would be far wiser than itemizing just to receive 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 slightly less than what the taxpayer would receive from taking the standard deduction. The “benefit” of the mortgage interest deduction is shown in the table below.

Structured this way, it is not surprising that a tax deduction arguably put in place to encourage home purchases tends to be used primarily by higher-income households.

Additionally, there is a limitation in place on how much of your mortgage interest can be deducted. For 2021, the limit is the mortgage interest paid on the first $750,000 of indebtedness for a married couple or $375,000 if single or married filing separately. A slightly higher limit exists for indebtedness that was incurred prior to Dec. 16, 2017 ($1,000,000 for married filing jointly and $500,000 if single or married filing separately).

A Better Way

Rather than spending large amounts of money on interest for little in return, you would be far better off to pay cash for your new house. A cash purchase will save you tens of thousands of dollars because you will not be paying interest.

Of course, 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 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 the home is 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; however, many homeowners don’t actually receive the tax benefit based on their financial condition. Before buying a home, take a look at what will work best for you, it might make more sense putting down more cash and avoiding as many interest payments as you can.