Can You Deduct Second Mortgage Interest On Your Taxes?

Will you be able to deduct second mortgage interest on your taxes if you have taken out a second home loan? It’s a good question – and one whose answer will no doubt affect your annual financial planning calculations. In general, the answer is yes, you can. However, be advised that there are certain terms and conditions that you’ll want to know to determine if you’re eligible to enjoy such tax deductions, as outlined below.

Are second mortgages a type of loan that qualifies for mortgage interest deduction within the framework of current tax laws for homeowners? You’ll want to make a point to ask yourself this question when plotting your annual budget, especially as a second mortgage (which allows you to borrow a lump sum of cash as needed) is a loan or line of credit that you choose to take out against the equity in your home. It differs from a mortgage refinance, which replaces your old home loan with a new home loan and allows you to access home equity without introducing the need for you to make another monthly payment.

The short answer is yes, fortunately for taxpayers, you can still deduct second mortgage interest, albeit only under certain terms. The type and current amount of mortgage debt that you possess, as well as the date on which your loan was originated, and other factors can affect whether or not you qualify for interest tax deductions. However, the good news is that in general the interest charged on mortgages for a second home and home equity loans is generally still deductible.

The Internal Revenue Service (IRS) uses the terms “mortgage interest” and “mortgage debt” in different ways. In simple terms, mortgage debt defines monies owed on the loan that you have taken out to purchase a single-family home, apartment, condo, townhouse, or other type of real estate property. By way of contrast, mortgage interest (expressed as a fixed or variable percentage rate of a total loan amount) describes the amount of interest that a lender charges you in fees for a loan that you use to purchase a piece of property.

Note that the two most common types of debts that you might expect to encounter as part of a second mortgage are:

• Home Acquisition – Debt associated with the purchase of a property. Homeowners can deduct the interest on a second mortgage associated with home acquisition debt so long as this debt is secured by the second home.
• Home Equity – Home equity mortgage debt is associated with a loan type in which a borrower leverages the equity of their home as a form of collateral. Homeowners can deduct the interest on a second mortgage that is related to home equity debt only if the loan was used to acquire, build, or substantially improve a main or second home.

Homeowners will need to meet certain qualifications, and steer clear of select restrictions, if they wish to be eligible to deduct interest on second mortgages in the current tax year. These guidelines are as follows.

Secured By Your Home

Per IRS findings, only second mortgage interest paid on acquisition indebtedness – i.e. a loan used to acquire, build, or substantially improve a main or second home – is deductible. This acquisition indebtedness must apply to the specific home that you have used to secure the second mortgage if you wish for any sums to become eligible for interest deductions.

Below The Total Mortgage Debt Limit

Mortgage interest is currently tax deductible up to the total amount of interest paid in any given year on the first $750,000 of your mortgage, or $375,000 if married filing separately. (Or $1 million for those who purchased homes prior to 2018 – or $500,000 if married filing separately.) For tax purposes, second mortgages are considered to carry mortgage interest because they use your house as collateral. Your current debt load will impact whether or not you can include second mortgage interest alongside your other homeowner tax deductions.

Grandfathered In With Prior Tax Treatments

Did your second mortgage originate on or before December 15, 2017? If so, you can enjoy the benefit of grandfathered debt.

In other words, you’ll find yourself grandfathered into previous historical tax guidelines – aka able to deduct interest on up to $1 million ($500,000 if married filing separately) of mortgage debt. (As opposed to current guidelines, which limit deductible interest to sums paid on up to $750,000 of mortgage interest payments, or $375,000 if married filing separately.)

Be aware that you can’t double dip, however. By way of explanation, you cannot take a grandfathered debt of more than $750,000 but less than $1 million and combine it with a new mortgage that brings you up to the $1 million cap. (See below examples for illustrations.) Under this circumstance, you’d be limited to deducting second mortgage interest on only the amount of interest that is associated with your original grandfathered debt.

Used To Pay For Home Improvements

As alluded above, the Tax Cuts and Jobs Act of 2017 now requires home equity loans and home equity lines of credit to be used for home improvements in order for taxpayers to become eligible to deduct the interest on their taxes.

Say Tim purchases a primary residence for $500,000, then acquires a new property as an investment home for $250,000. He is eligible to take second mortgage interest tax deductions (and primary mortgage interest tax deductions) paid on the sum total of the amounts borrowed ($750,000).

However, Zoe and her husband Bob – who purchased a piece of property for $850,000 in 2015, then took out a home equity line of credit for $50,000 in 2020 – are only eligible to deduct interest monies paid on up to $850,000 (the amount of the original mortgage.) That’s because the original grandfathered debt qualifies for second mortgage interest deduction under historical terms, but the home equity loan (which cannot be combined with this grandfathered debt to get around the current $750,000 IRS cap) does not.

Homeowners wishing to capitalize on second mortgage interest tax deductions will need to maintain documentation pertaining to any related transactions. Likewise, per IRS guidelines, they’ll also need to submit a 1098 Form provided by their lender alongside a Form 1040, Schedule A for itemized deductions. A qualified tax accountant can help you compile and get this paperwork in order.

Second mortgage interest is tax deductible in certain circumstances, provided minimum IRS qualifications are met and current federal tax guidelines are followed. This means that only a certain portion of expenses associated with your outstanding debts may be deductible. However, monies paid in second mortgage interest may help you recognize significant tax savings.

To learn more about possible tax deductions, consult your local tax specialist for specific questions regarding current tax policies. You can also read through our Learning Center for more insight and information as you navigate your way through other mortgage-related questions.