Does Your Loan Provide a Tax Deduction?

Certain types of loans qualify for a loan tax deduction, helping reduce the amount and rate of income tax you pay annually. Learn more below about the loan types on which you can deduct the interest you are charged and about the special conditions attached to each type.

Student Loans Interest Deduction

To have a qualifying student loan, you must be a student at a registered post-secondary institution. Your student loan must be used to pay tuition and related education expenses for yourself or your dependents. Your loan must be at a stage where interest is payable on it, and you must have applied for your student loan after 2001. You must be filing income tax as a single individual or on a joint return with your spouse but not as "married filing separately." For the 2010 tax year, your gross income must be below $75,000 for an individual ($150,000 for married couples filing jointly), and you and your spouse cannot be claimed as dependants on another person's income tax return. If you paid $600 or more in student loan interest for the fiscal year ending December 31, 2010, you will be sent a form 1098-E Statement of Student Loan Interest from the financial institution to which you paid the interest. You can deduct the full amount of interest you paid up to a maximum of $2,500 per year.

Mortgage Interest Deduction

Your mortgage loan interest is also tax deductible, provided your mortgage is up to $1 million for you and your spouse filing a joint tax return. You can claim the interest as a deduction on a mortgage of up to $500,000 if you are married and file separate income tax returns. The amount of interest you can deduct will depend on your mortgage's interest rate, your federal and state income tax brackets and your monthly mortgage payment. If you are a first-time home buyer, you are also eligible for other deductions in your first year of home ownership, including the loan origination fee, the points paid to lower the mortgage interest rate, and other fees. The length or amortization term of your mortgage, most commonly 15 or 30 years, will also determine your interest rate and monthly mortgage interest.

Home Equity Loan Interest Deduction

If you take out a home equity loan to make home improvements such as a new roof, adding a room or refinishing the basement, you can deduct the interest on a loan valued up to $100,000 of principal. If you have over $100,000 equity in your home, you can take out a larger loan, but it must be used for home improvement only. Retain your receipts and keep accurate records of spending so the loan funds' usage can be verified. A home equity loan can also be used for debt consolidation, but only the interest on the first $100,000 of the loan can be deducted for income tax reduction.

Loans Not Eligible for Interest Deduction

These include payday loans and personal loans to buy vehicles. Payday loans have a high rate of interest for a small amount of principal and are considered high risk. Vehicle purchase loans have a low interest rate with a small principal compared to a mortgage, so the interest is not deductible.

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