- The federal government does not allow you to claim the interest deduction on every home you own. You are limited to two mortgages: one for your main home and one for any other home you own. If you own more than two homes, you are free to designate any one as your second home for purposes of deducting mortgage interest. You can even change this designation each year if one provides a higher deduction than the other. However, there is no discretion in choosing which home you treat as your main home. Your main home is always the residence where you live for most of the year.
- Although you can deduct the interest on two homes, the amount of your annual deduction is not unlimited. To ensure that it's not subsidizing your purchase of luxurious mansions or beachfront properties, the IRS limits the deduction to the interest that accrues on up to $1 million of total mortgage loans. This is not an all-or-nothing test, though. Suppose your main home has a $600,000 mortgage and your vacation home has a mortgage of $700,000. This means you can deduct all the interest that accrues on your main home, plus the interest that accrues on $400,000 of the vacation home's mortgage.
- The IRS also requires that your mortgage lender have a security interest in your home before you can qualify for the interest deduction. Most mortgages in the U.S. will satisfy this requirement. This means that your lender remains on the home's title until you repay the loan in full. A security interest serves as collateral to the lender in case you default on repaying your mortgage. If you do, however, the lender has the right to foreclose on your property and sell it. Therefore, if you use a credit card or a personal loan from a family member to finance the purchase of your home, any interest you pay is not deductible since both lenders have no security interest in the home.
- The interest that accrues on a home equity loan you take out is also eligible for the mortgage-interest deduction, but with more restrictions. The same requirement that the lender have a security interest in the home also applies. However, the interest you can deduct is limited to that which accrues on the smaller of $100,000 of loan principal or the actual equity you have in the home. You can calculate your equity by subtracting the outstanding balance you still owe on your original mortgage (excluding the home equity loan) from the home's fair market value. The home's value is essentially the price a willing buyer would pay for it under current economic conditions.