The Advantages of the Mortgage Tax Deduction for the Average American Family

Most Americans consider owning a home to be a key component of the American dream. Home ownership, along with the associated increase in equity in that home, helps families build net worth. However, the down payment and mortgage payments that fund the dream can put a strain on the average American family’s savings and income. The IRS makes home ownership more affordable -- sometimes even cheaper than renting -- by providing a mortgage tax deduction.

Mortgage Interest

Mortgage payments are a large expense which, in the early years of the typical FHA or conventional 30-year loan, consists primarily of interest. The IRS allows you to deduct the interest paid on your mortgage for your primary home and a second home. To take full advantage of this potentially sizable deduction, you cannot use the standard deduction. You must itemize all your deductions on Schedule A of Form 1040.

Real Estate Taxes

You can also fully deduct any real estate property taxes on your home that you paid directly or through your mortgage's escrow account. The IRS defines a home as "a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities."

Illustration

In a real estate market when rents are high and mortgage interest rates are low, owning a home can be significantly cheaper than renting. For example, one family rents a three-bedroom, two-bath home for $1,200 per month in North Carolina or Ohio. In addition, you pay for all the regular maintenance including gardening service, minor repairs and snow removal. Because you rent, your tax deduction would be $0. A second family buys the house, at $170,000, with an FHA mortgage, which the average American family qualifies for. With a 3 percent down payment and 4 percent interest rate, the monthly mortgage amount would be approximately $800. With taxes, insurance and private mortgage insurance, that amount could increase to $1,100. However, with the tax deduction, you would be able to reduce your taxable income by almost $12,000 in interest and taxes for the year.

Equity

In addition to potentially owning a home for significantly less than the cost of renting, you can use the tax savings provided by the mortgage deduction to pay down your mortgage. Hence, over time, you build additional equity in your home by more rapidly reducing the loan balance.