Here’s one way high mortgage rates are benefiting homeowners

High interest rates are making tax returns more complicated for many new homeowners — but in a good way.

The mortgage interest deduction — a lucrative homeowners’ tax benefit taken on itemized returns — was limited by the Tax Cuts and Jobs Act (TCJA) in 2017, severely curtailing the number of households that can write off the interest they pay on their home loan.

But today’s high interest rates are tipping the calculation back in favor of claiming this largely forgotten benefit, providing some relief to beleaguered homebuyers.

Read more: Mortgage interest deduction: How it works and when it makes sense

High home prices, low inventory, and expensive mortgage rates have combined to create one of the most punishing housing markets in decades. This unexpected tax boon gives new buyers something to look forward to during filing season.

“The benefit of the itemized deduction definitely comes back into the picture,” Nicole Han, a Realtor based in Los Angeles and former accountant at Ernst & Young’s real estate tax practice, told Yahoo Finance. “It gives [homebuyers] a little bit of peace of mind knowing that when they make their mortgage payments, a big portion of the mortgage payments is going to the home’s equity and that interest can be deducted.”

How high rates can help with housing affordability

President Trump’s signature tax law significantly changed federal tax treatment of homeownership.

First, it reduced the amount of eligible principal to $750,000 from $1,000,000. This change impacted more high-value properties as their owners lost the interest deduction on $250,000 of principal balances.

Second, the law increased the standard deduction from $12,700 to $24,000. This meant far fewer homeowners benefited from itemizing their taxes partly because their low-interest mortgages had less interest to write off. Today only 13.7% of filers claim the mortgage interest deduction.

But then interest rates started spiraling, reaching a high of nearly 8% in October.

Consider the difference between 2021 and now. Three years ago, the average rate on a 30-year fixed mortgage dipped to around 3%, meaning the maximum amount of mortgage interest that a taxpayer could deduct in year one on a $500,000 loan was around $15,000 — far below the standard deduction of $25,100 for joint filers in 2021. Even if those taxpayers took a $10,000 maximum state and local tax deduction, it still wasn’t enough to justify itemizing.

Now, using a current rate of 7.14%, the same loan balance generates mortgage interest of nearly $36,000 in year one. The standard deduction was adjusted up to $27,700 for 2023 taxes, meaning recent homebuyers pass the threshold for itemizing with just their mortgage interest expenses — even before adding other itemized deductions.

Read more: Mortgage rates hover around 7% — is this a good time to buy a house?

It’s a rare silver lining for buyers.

“Might as well lock in with a high interest rate, get the house, and get those itemized deductions for that year because they already put so much down payment, so anything helps,” Han said. This change also hit high-value properties as many homeowners pay more than $10,000 in annual real estate taxes.

On average, homeowners received tax breaks of around $250 in 2018 and 2019, a drop from nearly $750 pre-TCJA, according to a report titled Heterogeneous Costs of Homeownership by the National Bureau of Economic Research. And those effects were not evenly spread: Researchers estimated that Democrat-voting areas, such as high-tax coastal states, lost $600 per household in annual tax benefits while Republican-voting areas lost $340 per household.

“A lot of the states with larger income tax obligations like California, New York, New Jersey, they’re feeling the hit,” said University of Miami accounting associate professor Diana Falsetta.

Homeowners received tax breaks of around $250 in 2018 and 2019, a drop from nearly $750 pre-TCJA. Homeowners received tax breaks of around $250 in 2018 and 2019, a drop from nearly $750 pre-TCJA.

Homeowners received tax breaks of around $250 in 2018 and 2019, a drop from nearly $750 pre-TCJA. (Michael Godek via Getty Images)

How to determine if you benefit

New homeowners with high borrowing rates can quickly determine if they can take advantage of the shift in tax outcomes — which may well apply to taxpayers beyond those in traditionally expensive cities.

New US buyers purchasing a median-price home for $402,343 would pay nearly $23,000 in mortgage interest the first year at current rates. That deduction, coupled with deductions for property taxes and state income tax up to $10,000, medical expenses, and charitable donations, could fairly easily surpass the threshold for the standard deduction.

In general, purchases with a lower down payment, higher loan balance, or higher interest rates enhance the tax benefit.

“I highly encourage (owners) to take advantage of that higher interest rate,” Han said. “It seems scary at first, but it’s worth it.”

Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).

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