Mortgage Interest Deduction, Limit & Phase Out

The mortgage interest tax deduction provides homeowners the ability to deduct the interest they paid on their mortgage(s) from their taxable income they earned for the tax year in question. Your primary residence isn’t the only mortgage interest deduction you can take advantage of. If you have a mortgaged second home, that interest paid over the course of a year for that mortgage can be deducted as well.

Countries such as the United State, Netherlands, and Switzerland are the only developed countries that offer a full interest deduction. Ireland, Sweden and Belgium offer a mortgage interest tax deduction, but only a small fraction.

There are many opinions on whether the tax deduction positively or negatively affects the United States economy. It has been argued that the deduction gives an incentive to purchase a home, which in return fuels the economy. While the opposition argues that the deduction artificially inflates home prices. In my opinion, regardless if the tax deduction positively or negatively affects our economy, if the deduction was taken away, home prices would plummet at least 15% percent.

Mortgage Interest Deduction Limit

There are two different types of mortgage debt called Home Acquisition Debt and Home Equity Debt:

Home Acquisition Debt: The IRS states that the most mortgage interest you can write off for Home Acquisition Debt is $1,000,000 and this goes for the first and the second homes as long as it’s used to acquire, construct, or substantially improve a home.

Home Equity Debt: You may also deduct up to $100,000 on your second mortgage as well, which is called Home Equity Debt as long as it’s NOT used to acquire, construct, or substantially improve a qualified home. However, you may not deduct over $100,000 for each mortgaged property that you own. In other words, even if you own multiple residences, you still can only deduct up to $100,000 per year.

Mortgage Interest Deduction Phase Out

If you gross more than $166,000, your mortgage interest deduction begins to get phased out Every $100 you earn over $166,800, you will lose three dollars of itemized deductions, or 33.3% up to a maximum loss of 80% of your itemized deductions.

What is a Good Credit Score to Buy a House in 2013?

Knowing what you credit sore is the greatest predictor on whether you’re going to be approved for a mortgage or not, so you might be wondering, what score do I need to get approved for a mortgage loan in 2013?

From the very start of the mortgage crisis back in 2007-08, many lenders have become more conservative in their lending guidelines.  Pre-mortgage crisis, you could get approved by your local bank or mortgage lender if your mortgage equaled 50% or less of your income and as little as if you had a social security number.

To get approved these days for a standard (conventional) mortgage, lenders are wanting to see the lower of your two credit scores, out of the three (Experian, Equifax, Transunion,) to be at least a 620 or above.  To be able to acquire the lowest interest rates, mortgage lenders are looking for credit scores in the 720 and higher range.  However, there are ways to get around having lower scores though such as government insured FHA and VA mortgage programs.

Your credit score isn’t the only requirement

Mortgage lenders also want for you to become invested in your home on day one. They want something else that ties you to the collateral more so than just your credit report – they want a healthy down payment. If you can come up with at least 20% of the purchase price of your home, you are able to meet this requirement. Some lenders do require less, but if you do find a lender that will accept less, then you are required to pay PMI (Private Mortgage Insurance.)

PMI is insurance that you pay monthly installments on and is included in your monthly mortgage payment to protect the lender in case of default. It’s estimated annually at .5% of the amount borrowed and then dived by 12 to be included within your mortgage payment.  Once you have built up at least 20%, you no longer have to pay.

There used to be a way to get around having to pay PMI and not coming up with the full 20% and perhaps nothing down at all. It was known as a piggyback mortgage, which for example was essentially two mortgage loans taken out at the same time with the smaller second loan was meant to fund the first loans’ down payment. These were also often called 80/20’s or 80/15’s, which ever percentage the second loan was. These loan products, also known as lines of credit, are pretty much extinct to people that do not have excellent credit.

Don’t forget about your debt to income ratio

So what does DTI mean? Debt to income ratio is the percentage of your debts compared to your income.  For example, let’s say that you have a car payment of $200, credit card payment in the amount of $25, rent and utilities in the amount of $500, and your income is $3,000. Once calculated, this would mean that you have a DTI income ratio 25% debt to income ratio, which is healthy and acceptable in the eyes of mortgage lenders.

The debt to income ratio requirement for conventional mortgage lenders is no greater than 28%. Let’s take a look back at pre-mortgage crisis real quick. Now the logic behind 28% makes a lot of sense, doesn’t it? Before the mortgage crisis, you could have your debt to income ratio as high as 50%! Are you starting to see a trend here?