The TurboTax and HR Block quick calulators appear to use average tax rate to determine tax savings. Our average tax rate was 15% this year. Most other calculators specifically designed for calculating mortgage interest tax savings use marginal tax rate, which for us is 25%. Which are we supposed to use for an accurate estimation of our tax savings? We’re thinking of buying a home and this weighs heavily in our decision process.
Compute your tax with out a home then add the home and see how much it changes.
If you get the standard deduction for a couple it is over 10,000 so that part is no savings. When you have a house you have property taxes and interest to deduct plus then your state income or sales tax and charity is deductable.
If you aren’t doing charity and pay $3,000 for property tax only any interest over about 6K will reduce your tax and it will reduce it at your marginal rate so you will save 25% of 6K or about 1,500 maybe 2,000 if you have high state taxes.
When calculating tax savings from mortgage interest, should you use your marginal tax rate or average tax rate
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Compute your tax with out a home then add the home and see how much it changes.
If you get the standard deduction for a couple it is over 10,000 so that part is no savings. When you have a house you have property taxes and interest to deduct plus then your state income or sales tax and charity is deductable.
If you aren’t doing charity and pay $3,000 for property tax only any interest over about 6K will reduce your tax and it will reduce it at your marginal rate so you will save 25% of 6K or about 1,500 maybe 2,000 if you have high state taxes.
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Always use the marginal tax rate to compute your tax savings–that’s the rate that the next dollar of income is taxed at.
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Years.
Marginal.
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Both of the above answers are correct.
The benefit of mortgage interest is that it lowers your income. The last dollar of income is taxed at your highest marginal rate…but if you have a lot of interest, you may drop to a lower tax bracket.
For most new home buyers, however, the benefit is much smaller than they expect. The real estate person/websites told them if they paid $20K in mortgage, they would get $5000 less in tax, completely ignoring the fact that you ALREADY get a married standard deduction of over $10000, so the reduction is more likely to be half what they expected…and then only if you had the house for the entire year.
The best way is to mock up a tax return and see what happens when you plug in YOUR interest into YOUR schedule A.
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Marginal rate. If you are only a little bit into that bracket though, the actual savings might not be that much, since some would only have been taxed in the next lower bracket. But don’t forget, if you itemize you no longer get the standard deduction, so your only real tax savings is based on the amount your itemized deductions are OVER your standard. So the estimate of tax savings is (total expected itemized deductions minus standard deduction) times tax bracket.
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