Refinancing your home can reduce your mortgage and give you access to equities in your home that you can use to pay off important expenses. When interest rates plummet, millions of homeowners across America decide to refinance their mortgages. But the tax rules associated with refinancing can be tricky, so before you refinance, do your own research or get in touch with one of our Tax Pros – we offer free income tax service consultation.
Should You Even Refinance?
This ’Should You Refinance Your Mortgage’ sheet from dummies.com will help you find the answer.
If you intend to live in the house for a few years longer than the break-even time, refinance away!
Tax Deductions from Refinancing
To help you understand how tax deductions from refinancing your mortgage works; let’s look at a hypothetical case.
Say your old mortgage was for $500,000, and you’re refinancing the mortgage for a loan of $550,000. You can use the extra $50,000 to pay off some loans and cover expenses like credit card bills. When it comes to your taxes, your new mortgage amount is split into two parts. One part is the original mortgage amount, which is home-acquisition debt. Interest on this debt, up to a million dollars of it, can be written off as an itemized deduction.
The other part is the money you took out when you refinanced. In this case, it’s the extra $50,000. This is called home equity debt for tax purposes. Interest on this for up to $100,000 is also deductible.
How Tax Works On Loan Origination Fees
Let’s break it down.
- Loan origination fees, also known as points, will be charged when you refinance.
- Each point is 1% of the new loan balance.
- Points for the home-acquisition debt must be amortized.
- Continuing with our example case, this is 1% of $500,000, or $5000 for every point.
- You can write off the amortization amount as interest.
- The 1% fee on the home equity debt can also be amortized over the duration of the loan.
Note: “amortized points” is just a fancy term for points that have been deducted.
Good News for Serial Refinancers
If you’ve refinanced your mortgage before, you probably have a hefty unamortized balance for the points you’ve collected. You can deduct this entire balance when you refinance again! But this doesn’t apply if you refinance with the same lender. In this case, you will have to continue amortizing points from the old loan and just use the new loan’s duration to figure the write-off.
The Deadly AMT
If you are eligible for alternative minimum tax (AMT), you can deduct interest on your home equity debt only if the money was used towards improving your home. So, if you used that extra money to pay credit card bills and clear car loans, you can’t deduct the interest.
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