When Is A 5.000 Percent Mortgage Rate Really 3.600 Percent?

Mortgage interest may be tax-deductible

An oft-touted benefit of homeownership is its tax benefits.  However, like most IRS-related items, understanding how the benefits work is not always clear.

In general, homeowners are entitled to two home-related tax deductions — one for annual mortgage interest paid, and one for real estate tax bills paid.

Not everyone is eligible, though.  Some of the exclusionary traits include total amount borrowed, and whether or not the home is a primary or secondary residence.

The official IRS publication is filled with notes and explanations but, in general, you can calculate your approximate mortgage interest tax deduction using the following math:

  1. Sum your annual mortgage interest and real estate taxes paid
  2. Find your tax rate on the IRS tax bracket schedule
  3. Multiple your tax rate by the sum from Step 1

This is grossly simplified, but fairly accurate.

As an example, a homeowner paying a combined $20,000 in 2008 mortgage interest and real estate taxes, and who is in the 28% tax bracket, may be due $5,600 in tax credits.

The availability of mortgage interest tax deductions is one reason why loan officers make reference to “after-tax mortgage rates”.  An after-tax mortgage rate is effective interest rate, post-tax code, and can be calculated using the formula below:

(After-Tax Mortgage Rate) = (Mortgage Rate) * (1 – Marginal Tax Rate)

The same homeowner with a 5.000% mortgage rate, therefore, has an after-tax mortgage rate of 3.600%.

Because not every homeowner is eligible for home-related deductions, and because not every homeowner should claim them, talk with your personal accountant before making any tax-related decisions.