I'm trying to figure out how much money I save with writing off mortgage interest. I know it reduces my taxable income. But how much actual money does this save me?

[john_porter_bill]

Looking at a refi of the house. Debating if we should pull money out or just refi to shorten life of the loan/overall costs.

I know we can write off mortgage interest, and that this reduces my taxable income. But if I pay an extra $20,000 over 15 years in interest, or $100,000 over 20 years, how much of that payment will I actually see in real dollars as far as a reduced tax burden?

[VolvoGirl]

First of all you need to see if have enough total itemized deductions to itemize since the Standard Deduction is now more.  Then only the amount that puts you over the standard deduction helps.  But it's not a 1:1 reduction.   It only reduces your tax by your tax rate.  So if you are in the 25% tax bracket a $100 deduction will reduce the tax by $25.   

For 2020 the standard deduction amounts are:

Single 12,400 + 1,650 for 65 and over or blind (14,050)

HOH 18,650 + 1,650 for 65 and over or blind

Joint 24,800 + 1,300 for each 65 and over or blind

Married filing Separate 12,400 + 1,300 for 65 and over or blind

[Critter-3]

General rule of thumb ... never pay $1 in interest just to possibly get a few cents back on your income tax return.  Pay off the loan as fast as possible to reduce the amount of interest you will pay in the long run.

The difference between paying $100K in interest and $20K in interest is a net savings of $80K which is way better than getting $10k  - $20k in reduced taxes over the same time frame. 

[Mike9241]

there's no way to know for sure because tax laws and tax brackets and rates change.

when I started out in public accounting the top rate was 93% so $100 in mortgage interest would cost only $7 after taxes. then the top rate change to 90%, then70% and today the top tax rate is 37% (give or take) but the tax laws have become much more complicated in trying to figure out what the mortgage interest deduction will save you.  complications include alternative minimum tax, tax on qualified dividends and capital gains, limitation on mortgage interest deduction, the additional medicare tax, and others. I suppose the worst-case scenario is you pay mortgage interest but don't have enough to itemize. then the mortgage interest saves you nothng.  

[Carl]

I know we can write off mortgage interest, and that this reduces my taxable income.

That statement is not always true when dealing with this on your primary residence, 2nd home, vacation home or any other non-business, personal use real estate. Mortgage interest on personal use property is a SCH A itemized deduction. Until the total of all of your itemized deductions (which can include more than just mortgage interest) exceeds your standard deduction, the itemized deductions make absolutely no difference to your tax liability.

Additionally, as of 2018 there are limits on your itemized deductions. You can deduct the interest on a mortgage balance up to $750,000. Interest paid on any amount over that is just flat out not deductible at all. There's also a limit of $10,000 on SALT (State and Local Taxes).

So if you're filing a joint return your standard deduction for 2021 will be  $$25,100 (unless congress changes it before the 2021 tax filing season starts.) If the total of all of your itemized deductions does not exceed that standard deduction, then itemizing won't help you a bit. So refinancing for the primary purpose of lowering your taxes is not really a good reason to refi.

Reasons I myself refi in order of importance to me are:

1) Lower the interest rate by an absolute minimum of 2%. If a refi will not lower the interest rate by 2% or more, then it's generally not worth while financially, to bother with a refi. (Not true for all. It depends on the outstanding balance of the original loan, if it's worth it to me or not.)

2) Lower the total monthly payment by "at least" 15%.

3) Lower the amount of interest I pay each month (thus increasing the amount of each payment applied to the loan so it gets paid off sooner.)

4) Change the term of the loan from a 30 year loan (original loan) to a 15 year loan (New, refi'd loan) which also gets me a lower interest rate.

Overall, I don't have any problems or issues with paying my share of taxes - but I only want to pay those taxes on the money I get to keep. So the sooner I can pay off a mortgage, the sooner I get to keep that money I'm paying taxes on anyway. (Basically, that's the principle portion of each payment that you pay taxes on.)

I recently refi'd my primary residence from a 5.75% 30 year loan, to a 3.0% 15 year loan which lowered my payments by around $300/month. So my payments went from roughly $1300 a month to around $975 a month. A $325 a month savings, and a whopping 25% drop in the total payment amount due each month. Additionally, and even with a 15 year refi loan, the amount of each payment that goes towards paying down the principle actually increased by about $32 a month.  Compared to the old original loan, that's almost the equivalent of making an extra payment towards the principle every year.

Note that this refi has had absolutely no impact on my tax liability. But it did put an extra $325 in "my" pocket every month, instead of the bank taking it.

[john_porter_bill]

Thank you all very much for those responses. This has been really helpful, and I truly appreciate all of your time. 

@Carl , I think I have a better handle on this. We're married filing jointly, and our itemized deductions won't be >$25K. If I have this correctly, we won't benefit from having mortgage interest of any kind, as we're not going to get above that threshold so there won't be any actual impact on our net taxes paid.

We're planning on refinancing the home. The question we were asking was whether it was beneficial to refi and just lower our interest rate/monthly payment (from ~5% to <3%) and get onto a shorter loan, or pull home equity out for projects but pay $20K extra over the life of the loan (15 year refi) or $100K extra (20 year refi). I had hoped that there was some sort of tax benefit to taking on that extra money that we would be paying in interest payments, but it sounds like it wouldn't. 

You made some great points about the necessity of a refi. Over the life of the loan, we're looking at substantial cost savings if we just refi and don't pull any equity. If we pull equity on a 15 year refi, it's basically a wash on our current mortgage vs what we'd get on a refi. If we pull equity on a 20 year refi, we'd end up spending quite a bit more over the life of the loan. But we'd have money in hand now for projects and our monthly payment would still go down. But all that said, it sounds like the true cost of borrowing this money is still substantial. Please tell me if I'm missing something obvious. Thanks a ton for all of your insight. 

[Carl]

There's a few things that need to be clarified about a cash out refinance. Overall it won't make any difference tax-wise if your itemized deductions don't exceed your standard deduction. But you need to be aware anyway. There could always be that one tax year with major medical expenses that could put your itemized deductions over your standard deduction.

Let's say at the time of the refi your current outstanding balance is $50K. If you refi only that $50K, then no problem. All of your interest is deductible.

But lets say you refi for $70K on a 15 year loan at 3.0% so you can cash out $20 to use for projects. Since your outstanding balance was $50K, only the interest you paid on the first $50K of the loan is deductible on the SCH A. So $50K is 71.4% of the refi amount that is used to pay off the original loan. Therefore, only 71.4% of the interest is deductible on the SCH A over the life of the new loan.

Now you mentioned you had projects that were going to run around $20K. If you use that $20K cash out amount to "buy, build, or substantially improve your primary residence" that is secured by that loan, then that would allow you to claim all of the interest as a SCH A itemized deduction. But the IRS tracing rules apply. That just means that if questioned, you have to be able to prove where that cash out money went.

A $50K 15 year loan at $3% will result in a payment of $346.55 per month. That amount does not include escrow that may be imposed by the lender for property taxes and insurance.