Mortgage interest deduction: how does it work?
Everyone who borrows money from a mortgage lender pays a certain amount for it: called mortgage interest. The mortgage interest deduction is a financial benefit devised to make buying a home more attractive. This deduction basically means that you can deduct the interest paid on your mortgage from your taxable income, albeit under certain conditions. The result is that as a homeowner, you have a lower official income and therefore pay less taxes. Below you can read more about how the mortgage interest deduction works, what it entails and what conditions exist.
The financial benefit of the mortgage interest deduction
The key question regarding the mortgage interest deduction is, of course, how much does it benefit you? This ultimately depends on your own income. The more you earn, the greater the tax benefit of the mortgage interest deduction. After all, you deduct the interest at the same rate as the percent tax on your income.
How does the mortgage interest deduction work?
The mortgage interest deduction can be deducted from your income by placing it in Box 1 of your tax return, namely income from work and home. The deductible portion of your interest depends largely on:
- The interest you pay
- Your own income
Keep in mind that you will always have to deal with a tax addition, called the owner-occupied home lump sum. This is an amount that is added to your income if you are a homeowner. The amount depends on the WOZ (Real Estate Value) of your home itself.
Then tax deductions are taken, including the mortgage interest deduction and deductible expenses that were necessary to purchase the home. By adding the home equity and the tax deduction together, you as a homeowner end up paying less taxes.
The Hillen Act
You may pay more taxes on your income when you pay no or little interest. This is the case if you have a small home equity debt (home equity debt is loans you took out to buy, maintain or renovate your home) and the home equity debt exceeds the calculated tax deduction.
If there is a small or no owner-occupied home debt, as a homeowner you are entitled to a deduction anyway, as described in the Hillen Act. Typically, this deduction is as high as the difference between the deductible expenses - such as the interest - and the owner-occupied home lump sum. This is an important element in the tax return, so at the end you don't pay taxes on the owner-occupied home lump sum of your home.
The mortgage interest deduction and deductible expenses
Once the home equity is added, it's the turn of the mortgage interest deduction. It is important to note that you may only deduct that interest from your owner-occupied home debt. In doing so, there are also specific conditions regarding the date you took out your mortgage:
1. A mortgage taken out after Jan. 1, 2013
If you took out an annuity or straight-line mortgage after Jan. 1, 2013, you are entitled to a mortgage interest deduction. Special repayment rules apply if it is the first time you have taken out a mortgage after that date:
- The maximum term of the mortgage is 30 years
- It must be a straight-line or annuity mortgage
Repayment-free mortgages, in other words, are excluded from this scheme!
2. A mortgage taken out before Jan. 1, 2013
In case you took out a mortgage for your home before Jan. 1, 2013, you may continue to use the deduction on your mortgage for the years remaining.
This arrangement is also called the transitional right. It basically means that for your personal situation you do not have to take into account the repayment rules of the new guideline.
However, those rules take effect when:
- You remodel the home and apply for a higher mortgage
- You are moving and need a new or higher mortgage
Please note: The transitional right expires if you sell your current home and then rent another house or apartment, without buying a new home at the latest in the following calendar year and thus also taking out a new owner-occupied home debt.
The deductible interest and additional expenses
The mortgage interest deduction is a great tool for homeowners to pay less in taxes. Contrary to popular belief, however, it does not necessarily involve deducted mortgage interest.
In fact, it is also possible to deduct interest from other current loans when they relate to and are part of the owner-occupied housing debt. Good examples are:
- Interest on a home renovation or maintenance loan
- Costs associated with surrender of leasehold rights
- Mortgage brokerage fees
- Transfer fees for switching to another mortgage provider
- Notary fees for preparing the mortgage deed
- NHG (National Mortgage Guarantee) application fee