Deduction Dangers, Part 1: Mortgage Interest

Avoid 3 common mistakes when claiming the mortgage interest deduction.

Laura Adams, MBA
5-minute read
Episode #260

Taking the mortgage interest deduction is one of the best ways for homeowners to save money on taxes. But how does it work exactly?

If you’re a homeowner or you want to be one someday, I’ll give you an overview of the mortgage interest deduction and 3 common mistakes you must avoid when claiming this valuable tax break.

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What is the Mortgage Interest Tax Deduction?

A tax deduction is an amount you can subtract from your taxable income, which reduces the amount of tax you have to pay. When you borrow money to buy, build, or remodel your home the mortgage interest deduction allows you to avoid paying tax on the interest.

Let’s say you get a fixed-rate mortgage of $200,000 for 30 years with a 4.5% interest rate. Your payment for principal and interest would be just over $1,000 a month, or $12,000 a year. In the first year, the interest portion of your payments would total over $8,900.

If you claim the mortgage interest deduction, that’s $8,900 of your income that won’t be taxed. Depending on your tax rate, claiming the deduction could reduce what you owe or increase your tax refund by thousands of dollars.

Who Can Claim the Mortgage Interest Tax Deduction?

In order to be eligible to take the mortgage interest deduction, you have to meet the following 2 conditions:

1.  You must file taxes on Form 1040 and itemize deductions on Schedule A.

There are 2 ways to claim your tax deductions: take a standard deduction or itemize. You get to choose the method that gives you the lowest tax bill and saves you the most money.

Here are the standard deductions for 2012:        

  • $11,900 or married couples filing jointly
  • $8,700 for those filing as head of household
  • $5,950 for singles and married taxpayers filing separately

So if you’re single and the total of all your eligible deductions—for expenses like mortgage interest, property taxes, charitable contributions, and a certain amount of medical expenses—is more than the standard deduction of $5,950, then you’ll come out ahead by itemizing.

2. Your mortgage must be a secured debt on a qualified home in which you have an ownership interest.

A debt is “secured” when you sign a legal document—such as a mortgage, deed of trust, or a land contract—that allows the lender to sell the property if you don’t repay the loan. You can deduct interest paid on mortgage balances up to $1,000,000. Additionally, interest paid on up to $100,000 of home equity loans or lines of credit is generally tax deductible.

Now that you know the basics about the mortgage interest deduction, let’s cover 3 specific mistakes about claiming it that can trip you up and cost you money.

Mistake #1: Getting Confused by Form 1098

Lenders send out a mortgage interest statement, called Form 1098, when you pay at least $600 of interest during the year. What’s confusing about this statement is that when there are multiple borrowers, a lender may only list one of them send it to that person only.

Let’s say that you couldn’t qualify for a mortgage by yourself, so your dad co-signed a mortgage with you. You live in the house by yourself and make all the payments. If the lender sends Form 1098 to your dad, you may not realize that you’re eligible to claim a deduction for the full amount of mortgage interest that you paid. 

Additionally, your dad may mistakenly believe that he’s entitled to the deduction because he received the form. Remember that no matter who receives Form 1098, each borrower is only entitled to deduct the amount of mortgage interest that he or she actually paid during the year.

If you own a home with someone else and they receive Form 1098, ask for a copy. Or file a paper tax return and attach a document that explains why you don’t have a copy of Form 1098 and how much interest each borrower paid during the year.

Mistake #2: Claiming a Deduction for Someone Else’s Debt

The second mistake to avoid is claiming the mortgage interest deduction on a loan that isn’t yours. A podcast listener named Lindsay asks:

I live with my boyfriend in a house that he owns. He’s been out of work for some time and I’ve been making the mortgage payments. Can I deduct the mortgage interest?

The answer is no. You can only deduct your share of mortgage interest on debt that you own. So no matter how much mortgage interest you pay for someone else, you can’t take a deduction for it unless you have an ownership interest in the property.


About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.