How Do Principal and Interest Work with Tax Deductions? Is That a Factor When Getting a Mortgage?

The transition to homeownership often comes with an array of new expenses: mortgage payments, real estate taxes, insurance, property repairs, home improvement projects… The list goes on and on. With costs running high, it’s no wonder many homeowners are relieved to learn about mortgage tax benefits. Read on to learn how homeownership can help you save money come tax time.

Mortgage tax deductions

Deductions reduce the amount of your taxable income – a goal for many American taxpayers. But what tax deductions for homeowners are available?

Can I deduct principal payments?

The principal of a mortgage is the amount you borrow for the loan. Your mortgage payments that go toward the principal reduce the loan balance. These payments are not tax deductible.

Can I write off mortgage interest?

In many cases, yes. The mortgage interest tax deduction is a favorite among homeowners because so much of mortgage payments go toward interest — especially in the first years of the loan.

The Internal Revenue Service (IRS) documents rules for mortgage interest tax deductions in Publication 936: Home Mortgage Interest Deduction . Generally, you can deduct the entire interest portion of your mortgage payment if you itemize your deductions on Schedule A (Form 1040).

To be deductible, the interest you pay must be on a loan secured by your main home or a second home, regardless of how the loan is labeled. The loan can be a first or second mortgage, a home improvement loan, a home equity loan, or a refinanced mortgage.

However, there are mortgage deductions limits to be aware of:

• Loans taken out after December 15, 2017 – limit of $750,000 ($375,000 for married couples filing separately)
• Loans taken out on or before December 15, 2017 – $1 million ($500,000 for married couples filing separately)
• Loan proceeds not used to buy, build, or substantially improve your home – not eligible unless the loan was taken out before October 13, 1987; see IRS Pub. 936
• Loans exceed the fair market value of the home; see  IRS Pub. 936

What other home expenses can I deduct?

Homeowner tax benefits go beyond traditional interest payments. Here are a few benefits you may want to take advantage of:

• Mortgage Insurance – Qualified mortgage insurance includes those required through Department of Veterans Affairs (VA) loans, Federal Housing Administration (FHA) loans, and private mortgage insurance (PMI).
• Points – The mortgage points tax deduction includes loan origination fees and discount points. Because they are prepaid interest, these items are deducted over the life of the loan and not all in the year you paid them.
• Real Estate Taxes – The deduction for state and local taxes, including real estate taxes, is limited to $10,000 ($5,000 for married couples filing separately).

Standard vs. itemized deductions

It’s important to know there are two deduction options on your federal tax return. You can either take the standard deduction or itemized deductions.

Here are the standard deductions for 2022:

• Single or married individuals filing separately – $12,950
• Married couples filing jointly – $25,900
• Head of household – $19,400

The only way to claim the mortgage tax credits we’ve discussed is if you itemize deductions. If you decide to itemize, be sure your total deduction is greater than the amount of the standard deduction. We recommend using a mortgage interest tax calculator if you’d like to estimate your deduction, and consult a tax advisor before making a decision.

Remember, the goal is to choose the option that saves you more money.

The IRS details the type of expenses homeowners can and can’t deduct in Publication 530: Tax Information for Homeowners.

Explore more homebuying benefits. Visit the PenFed Mortgage Knowledge Center.