When you are considering how much you can afford to borrow for a mortgage, consider the potential tax savings of the mortgage income tax deduction. Depending on the size of your deduction and your marginal tax bracket, the savings could be substantial. Planning ahead for your deduction can help you better estimate how much you can afford.
Calculating Your Savings
The mortgage interest break is a tax deduction, rather than a tax credit. This means your mortgage interest lowers your taxable income rather than directly lowering your tax liability. Calculate your tax savings from the mortgage interest deduction by multiplying your marginal income tax bracket by your interest deduction. For example, if you fall in the 30 percent interest and can deduct $15,000 of mortgage interest, you would save $4,500 on your income taxes.
Size of the Mortgage Interest Deduction
The mortgage interest deduction only allows you to write off the interest on the first $1 million of your mortgage debt. If you are married but elect to file separate returns, the IRS allows each spouse to write off the interest on no more than $500,000 of mortgage debt each. For most people, this still allows you to write off all of the interest. However, if your mortgage is more than the limit, you can only write off a limited portion.
Marginal Income Tax Bracket
Your marginal income tax rate is the income tax rate paid on your last dollar of income. The IRS uses a progressive tax rate structure, so you do not pay the same income tax rate on all of your income. You can find the income tax brackets in IRS Publication 17. The more income you have, the higher your marginal rate will be.
Giving Up the Standard Deduction
When you itemize your deductions to claim the mortgage interest tax deduction, you cannot claim the standard deduction anymore. If the mortgage interest deduction is the only deduction you are claiming and your mortgage interest deduction does not at least equal the standard deduction, you will pay extra on your taxes. However, when you itemize, you can also write off a number of other items including charitable donations, state and local income taxes or state and local sales taxes and investment interest.