At one time, home mortgage interest was an unlimited itemized deduction for income tax purposes. Many people still believe there is no cap on the deductibility of home mortgage interest.
I was in a presentation at the Broomfield Chamber of Commerce where Fran Coet, managing partner of CPA firm Coet & Coet, described recent changes to deductibility of mortgage interest. The net effect is that both the interest on first mortgages and HELOCs are capped so that interest above a certain limit is no longer deductible. This primarily affects the interest on loans where the new balance exceeds the original purchase price of the home or HELOCs above $100,000.
With increases in the standard deduction, many people who have owned a home for a long time have deductibility limits that are so low that there is effectively no deductible interest. As an example, a couple filing jointly would have a standard deduction of $10,900 in 2008 if they do not itemize. If they paid 5% interest on a $200,000 loan, the interest paid would be $10,000. If they had no other itemized deductions, they would save nothing by itemizing their interest deduction. Effectively, none of their interest payments result in any tax savings. Since the deduction is also limited based on the purchase price of the home, and the average sale price of homes in the Denver area was below $200,000 until 1999, many home owners will not qualify for any interest deduction even if the home has increased in value and a larger loan has been obtained.
I recommend that these limits be reviewed with a professional tax preparer to see if your home mortgage interest is really reducing your tax bill. Home mortgages are still a low cost way to borrow, but I was surprised to learn that the tax savings from paying home mortgage interest may be much less than some people believe.