Calculating Deductible Interest if Limits Apply

If the limits apply, there is a table in IRS Publication 936, Home Mortgage Interest Deduction, that will help you go through the calculation to see how much of your interest you can deduct.

Calculating Average Mortgage Balance

You can use the highest balances during the year on each mortgage loan you have in order to determine your limit, but it may be more beneficial to use an average balance for each loan.  There are different ways to calculate this average, as follows:

• Average of first and last balance method.  Under this method, you add the mortgage balance as of January 1st and December 31st and divide by two.  You can use this method provided you did not borrow any new amounts on the mortgage during the year, you did not prepay more than one month’s principal, and you had to make payments at regular intervals.
• Interest paid divided by interest rate method.  Here you take the total interest you paid during the year and divide it by the annual interest rate.  If the rate was variable, you use the lowest rate.  You can use this method if interest was paid at least monthly.
• Statements provided by your lender.  You can use either the closing balance or the average balance reported on each month’s statements, add them together and divide by the applicable number of months.

Mixed-use Mortgage

A mixed-use mortgage is a loan that involves more than one of the three categories of debt (grandfathered debt, home acquisition debt, and home equity debt).  For example, if you took out a mortgage loan partly to refinance a previous loan to buy your home (home acquisition debt) and partly to pay college expenses (home equity loan), this would be considered a mixed-use mortgage.  In this case, rather than using the methods previously mentioned, you should calculate the average balance of each portion of the loan separately, using the following method:

1. Determine the portion of the loan that applies to grandfathered debt and home acquisition debt for each month.  Reduce this amount by the principal payments applied in full to each category until that balance is zero, in the following order:
1. First, any home equity debt
2. Next, grandfathered debt
3. Finally, home acquisition debt
2. Add together the average monthly balances determined in step 1.
3. Divide the result of number 2 by 12.