How to Calculate an Effective Mortgage Rate With a Tax Writeoff

by Mark Kennan

One of the most popular itemized tax deductions allowed by the Internal Revenue Service is the mortgage interest deduction. Since the limit for the deduction is the first $1 million ($500,000 for married couples filing separately), most people can write off the entire amount of interest paid, which significantly lowers the effective mortgage rate. You can find the total interest paid on Form 1098 that your lender mails to you for use with your income tax return.

Multiply the annual interest paid on the mortgage by your marginal income tax rate to find the tax savings of the mortgage. Your marginal income tax rate is the highest tax rate you pay when you file your federal income taxes. For example, if you paid $20,000 in mortgage interest for the year and you fall in the 32 percent tax bracket, multiply $20,000 by 0.32 to find that your mortgage interest deduction saved you $6,400.

Subtract your tax savings from the total interest paid to find the after-tax cost of the mortgage. In this example, subtract $6,400 from $20,000 to get an after-tax cost for the mortgage of $13,600.

Divide the interest paid by the amount you owe on your mortgage to find the effective mortgage interest rate after accounting for your tax writeoff. In this example, if your mortgage balance is $350,000, divide 13,600 by 350,000 to get 0.0389.

Multiply the effective interest rate expressed as a decimal by 100 to find the effective interest rate on your mortgage expressed as a percentage. Completing this example, multiply 0.0389 by 100 to get 3.89 percent, which is the effective interest rate after the tax writeoff.

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