How a 5.0 Percent Mortgage Rate Might Equal 3.6 Percent

In San Diego real estate circles, we’ve all heard about the tax benefits of homeownership.  However, like most IRS-related items, understanding how the benefits work is rarely clear.

Generally, homeowners are entitled to two home-related tax deductions: One for annual mortgage interest paid, and the other for real estate tax bills paid.

However, not everyone is eligible.  Some of the exclusionary to be aware of 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 you can usually 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 generally 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 key reason why loan officers will frequently make reference to “after-tax mortgage rates”.  An after-tax mortgage rate is an effective interest rate, post-tax code, and can be calculated using the formula below:

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

This hypothetical San Diego 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, consult with your personal accountant before making any tax-related decisions.