DEFINITION of ‘Mortgage Interest’

DEFINITION of ‘Mortgage Interest’

Mortgage interest is the interest charged on a loan used to purchase a residence. Mortgage interest is charged for both primary and secondary loans, home equity loans, lines of credit, and as long as the residence is used to secure the loan.

Mortgage interest is deductible on form 1040.

BREAKING DOWN ‘Mortgage Interest’

Mortgage interest is one of the major itemized deductions personal taxpayers can have. Only the mortgage interest on the first $1 million (aggregated) of a first or second home purchase can be deducted on the Schedule A.

Mortgage interest on rental or investment properties can be deducted on Schedule E.

Requirements for a Mortgage Interest Deduction

As long as the homeowners meet the criteria set by the IRS, the full amount of the mortgage interest paid during the tax year, within the dollar limit, can be deducted. The mortgage interest can only be deducted if the mortgage is secured debt, where the home is put up as collateral as a way to protect the lender’s interests. The mortgage must also be for a residence that is a qualified home, meaning it is the owner’s primary home or a second home, with certain stipulations on its usage when not occupied by the owner.

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The interest charged on mortgages is typically outlined in the terms of the financing agreement. Mortgage interest can be set at a fixed rate, with adjustable rates, or a combination of both with a hybrid adjustable-rate mortgage.

With a fixed-rate mortgage, the mortgage interest will be based on a set percentage over the lifetime of the loan. This is frequently seen with long-term financing that carries a term that could be as long as 30 years. The borrower in this instance should have a clear expectation of how much mortgage interest they will be paying, along with the balance, over the course of ownership in the residence.

Under an adjustable-rate mortgage, the borrower may be subject to the fluctuations of the market. The mortgage interest they would pay, on top of repaying the principle balance, is based on a rate that is assessed and reset at regular periods, usually on an annual basis. This type of mortgage interest is more often found with shorter-term financing.

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With a hybrid adjustable-rate mortgage (ARM), the mortgage interest is initially subject to a fixed rate. After the initial period ends, the interest rate resets and becomes adjustable. The mortgage interest paid at the onset should be consist, with the later adjustments enacted on an annual basis.