If you have a mortgage loan, you are well aware of the tax deduction you get each year for the interest. Once per year, all that interest you pay to your bank gives you a benefit as well. By strategizing your monthly payment schedule, you can further benefit from the tax savings available from the mortgage interest deduction. We cover how it works below. You can also work with a financial advisor to create a tax plan that meets your overall financial goals so that you know when to make an extra payment.
What Payments Count Towards a Tax Deduction
You must make a mortgage payment before the end of the calendar year if you want it to count for a potential tax deduction. Technically, the January payment covers interest that accrued during the month of December, making it eligible for this year’s tax accounting. Paying any further in advance would be considered “pre-paid” interest, making it ineligible for this year’s tax deduction.
After the first of the year, your bank will send you a 1098 form itemizing the total interest you paid in the current year. It is measured by the calendar year, not the amortization schedule. What this means is that if you make your January payment now—being sure it posts to your mortgage before Dec. 31—the interest from that extra mortgage payment will count toward this year’s deduction.
When to Pay Your Mortgage Early
Knowing when to make an early mortgage payment in order to benefit your taxes is going to depend on your individual situation. For example, if you had or expect a large change in your income from one year to the next, that would be a reason to choose to pull the savings into this year, or to defer it to next year.
If your loan payment includes monthly mortgage insurance, then your savings will be even greater because mortgage insurance is also tax deductible. Of course, if you do this strategy now, you will have less of a deduction for the next year. Conventional wisdom, considering the time value of money, says to take savings now rather than later, if all other factors are equal. But consider the possibility both ways.
How to Make an Extra Mortgage Payment
If you plan to make an extra mortgage payment before the end of the year, make sure you communicate your intentions clearly with your bank. Sometimes banks assume that an extra mortgage payment made ahead of schedule is intended as a principal reduction. While there are advantages to making extra principal payments as well, it does not benefit you on your tax bill.
If you have a coupon book for your mortgage, you should be able to send in a future payment with the appropriate coupon and a note asking for it to be applied to your mortgage immediately. If you receive a monthly bill for your mortgage, then you will have to mail your payment even if you haven’t gotten the bill yet.
Make sure you include very clear instructions with your check, or better yet, go into a local branch if your mortgage lender has one. If your mortgage is set up on an automatic payment withdrawal, you will need to clarify that your check supersedes the next month’s auto-draft.
Disadvantages of Paying Down Your Mortgage
Before you make an extra mortgage payment, keep in mind that not all mortgages have a tax-deductible interest. Typically, mortgage interest on an owner-occupied home is deductible, while the interest on a rental property can be counted as an expense against rental income. Interest in a second home or vacation property is typically ineligible.
There may be a cap to the maximum amount that can be deducted based on the specifics of your loan and the state you live in. If you are unsure, it is always a good idea to talk with your tax advisor to see if you face any restrictions in mortgage interest deductibility.
The Bottom Line
Making an extra mortgage payment that isn’t intended to be a paydown of your principal can provide a tax break because you’re paying more in mortgage interest. This qualifies for a tax break as long as you do it before the end of the calendar or tax year. This can be a good way to get a tax break in a year that you may need if your income was higher than expected. It can also be a nice way to pay down your mortgage faster.
Tips for Getting a Mortgage
- Consider seeking the advice of a financial advisor before you make this or any other significant financial decision. A financial advisor can help you create a financial plan that involves paying off your mortgage and creating strong tax strategies. Finding the right financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When you’re applying for a mortgage, one of the largest expenses is typically the down payment. You can use SmartAsset’s free down payment calculator to help you determine how much you might pay.
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