Q: We have just received a form from our lender, indicating the amount of mortgage interest we paid last year. We are in the process of preparing our 2002 income tax return, and obviously the more deductions we can take the less tax we will have to pay. We believe that we paid more interest than is reported by the lender.. How do we know that the math is correct?

A: That’s a very good question. All too often, we take for granted the information we receive from our mortgage lender, and never bother to check the figures ourselves. When we file our income tax returns, we generally are pushing up on the April 15th deadline and do not have the time -- or the patience -- to confirm the information. And when we go to sell our house, the excitement of the settlement process often makes us overlook an important issue: was the loan payoff statement provided by our lender accurate.

Different lenders have different computer programs. However, at the end of each year, a mortgage lender is obligated to provide each borrower with a statement indicating how much mortgage interest was paid during the previous year, and – if taxes were collected in escrow – how much was paid for the real estate taxes on the property. This is IRS Form 1098. The lender sends the form to you, the borrower, and also advises the IRS of this information (on Form 1096).

When you file your income tax return, the IRS can then confirm that the information it received from your lender is identical with the amount of mortgage interest reported on your tax return.

Some mortgage lenders provide their borrowers a running monthly statement, showing the old loan balance, the amount of the payment broken down into interest and principal, and the new loan balance after crediting the principal payment. Keep in mind that when you make a mortgage payment to your lender, interest is calculated first on the then-outstanding balance, and the difference goes toward reducing principal.

Let’s look at this example. You borrow $150,000 at 6 percent interest, to be amortized over thirty years. The computer – or an amortization program – tells us that the monthly payment required to fully pay off (amortize) the loan over a full 30 year period is $899.34. If we do some basic mathematic calculations, the first payment consists of $750.00 for interest and only $149.34 for principal.($150,000 times 6 percent divided by 12 gives you the first month’s interest). It should be noted that for the first seven years, you will be paying a lot more interest than will be credited toward the principal balance.

Thus, our example looks like this for the first two payments::

Interest is always calculated on the then outstanding balance for the previous month, which is why the interest goes down (ever so slowly at first) and the principal goes up (every so slowly).

If you did not make any extra payments over the life of your loan, these calculations can be done quickly – either by hand or preferably by using a computerized amortization program. However, if you have made a larger monthly payment, then you have to do the numbers. Let us further assume that in the third and fourth month, you decided to make a payment of $1,000, instead of the regular payment. The next two month’s calculation would look like this:

As can be clearly seen, if you make a larger payment every month, you will significantly reduce the length of your loan. In fact, if you make one extra monthly payment per year, you will reduce a 30 year loan down to approximately 22 years. If you decide to make these extra principal payments, make sure that you clearly notify your lender each time that you are making such extra payments. Write

“Extra Principal, $___” on both the check and the mortgage statement which you send in to your lender.

If you do not have access to a computer, the math calculations – while easy – can be time consuming. Thus, each and every year, when you get your year end statement, you should spend a few minutes doing the calculations for the previous year, so as to confirm that the numbers are correct.

If you are having trouble reconciling your numbers with those provided by your lender, you should immediately request a payment history statement from your lender. At least once a year, your lender should be able to provide this to you – free of charge. Examine the statement carefully; make sure that you have not been improperly charged late fees or other similar charges. Make sure that any extra payments you may have made during the previous year have, in fact, been properly credited toward your principal balance.

There may be another reason why your calculation of the mortgage interest you paid last year is higher than the 1098 received from your lender. As we all know, lenders often sell their loan documents to other lenders. It may be that you should have received two form 1098s – one from each of the lenders that serviced your loan last year. While this may take a bit more research – and investigation – it is important that you determine exactly how much you paid last year for mortgage interest, and that the 1098 form (or forms) coincide with your numbers.

Lenders and their computers are not always correct. But only you can confirm your own mortgage balance. After all, it is your money -- and your tax deduction -- we are talking about.

Published: April 14, 2003

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