Mortgage interest has long been available as an income tax deduction for those that itemize deductions on their returns. In fact, it was one of the few deductions that avoided the Reagan tax cuts of 1981. And it’s a sizable deduction and can have quite an impact on the amount of dollars owed to the federal government. For someone in the 24 percent tax bracket for example paying $15,000 in a single calendar year, that amounts to a savings of more than $3,000 in federal taxes. But with the Trump tax cuts that took effect January 1 of this year, not only did all tax brackets see some sort of an income tax reduction, home owners taking out a mortgage or a home equity loan in 2018, there are some changes.
Keeping mortgage interest as a tax deduction is thought to encourage home ownership. The theory is that buying a home spurs other economic activity and it does. When someone buys a home there can be some remodeling done. A master bath gets a makeover or a new kitchen is put into place. New furnishings are bought and other household related items are purchased. Yet even though mortgage interest is tax deductible it’s debatable at best to think that mortgage interest deductibility is a primary motive for buying instead of renting. Mortgage interest is a tax advantage compared to someone paying rent each month but it’s a tangent benefit.
For those filing their income taxes for tax year 2017 there won’t be any changes as it relates to mortgage interest but will affect those taking out new loans in the coming year. In the past, homeowners could deduct mortgage interest on loans of up to $1 million. That has changed significantly with the new tax code that took effect. Going forward, homeowners can deduct mortgage interest on loans of up to $750,000, a reduction of $250,000. Granted, that’s not going to affect most homeowners as the average loan amount nationwide is somewhere near $245,000, but for those who finance higher end homes they’ll certainly feel the effect.
Both first and subordinate loan interest can be tax deductible. For subordinate loans used to purchase a home, interest on second liens is also eligible as a tax deduction. Buyers can choose to put down 5 or 10 percent on a purchase and keep the first mortgage at 80 percent of the appraised value, thus avoiding private mortgage insurance.
Subordinate loans also include equity loans, loans that are taken out using existing equity in the home. Equity loans can be used for most any purpose from paying off higher interest credit card debt to student loans to automobiles. There are no restrictions. As a plus, equity loans provide some of the lowest consumer interest rates around, especially compared to a credit card or personal loan. But with the introduction of the new tax laws for 2018 there are some changes. Going forward, homeowners can deduct mortgage interest on subordinate loans up to $100,000 as long as the funds are used for home improvements.
If the funds from an equity loan are used to pay off credit card debt, student loans or any other consumer credit item, interest is no longer tax deductible. And this is a major change. Equity loan decisions can be swayed by deductibility, perhaps more so than when thinking of buying a home. It really doesn’t take too much consideration when deciding whether to take an equity loan with rates in the single digits compared to a much higher credit card rate. The savings are immediate and the new payments for the equity loan turn out to be lower than the car payment. Further, in the instance of a home equity line of credit, it’s a revolving account and can be used over and over again just like a credit card.
Finally, there are changes as it relates to state and local taxes, sometimes referred to as SALT payments, only those amounts up to $10,000 may be deducted from taxable income. Leading up to 2018, homeowners could deduct the entire amount of state and local taxes paid. For someone in that same 24 percent tax bracket with $20,000 in state and local taxes paid last year, filers who itemize will still be able to deduct the entire $20,000 resulting in a savings of nearly $5,000. Next year however, the $10,000 limit will apply. There has been mention of homeowners rushing to pay their 2018 state and local taxes upfront to avoid the changes but the IRS recently stated that unless homeowners have received a tax assessment for 2018, those prepayments cannot be included. Of course, any and all tax questions should be directed to your CPA or financial planner, but in general, these are some relatively major changes that will affect more homeowners.
The author, Matt Herbolich, MBA, JD, LLM NMLS #1649154, is a senior loan officer at USA Mortgage, a division of DAS Acquisition Company, LLC NMLS# 227262. Contact Matt Herbolich, MBA, JD, LLM for your Real Estate and Mortgage Questions. USA Mortgage is a direct lender with no lender overlays on Government and Conventional Loans. Mr. Herbolich can be reached 7 days a week at 888-900-1020 by phone, on his cell at 786-390-9499 by either phone or text, or by email firstname.lastname@example.org.