Tax Implications of Refinancing a Mortgage
The government encourages Americans to own the home they live in through offering tax deductions with costs related to financing the home with a mortgage. The IRS requires mortgage lenders to provide each borrower with form 1098. This form outlines potentially deductible items as related to your home mortgage. Not everyone is able to deduct all of the possible deductions every year. Some people make too much money to deduct mortgage interest or points from their tax returns. Others have loans too high to qualify as well.
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Mortgage Interest
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Mortgage interest is a well-established deduction. The first federal income tax code allowed all interest to be deducted regardless of loan type. The modern tax code allows the deduction of mortgage interest from the primary and sometimes vacation homes. If you refinance your mortgage to a lower interest rate, your payment reduces as well. The loan amount didn't shrink, just the amount of interest paid, so the amount you can deduct also shrinks. If your interest deduction brings your income into a lower tax bracket, you may want to ensure you will not pay a higher percent of income taxes just because you lowered your mortgage's interest rate and corresponding tax deduction. Ensure the savings are still worth the cost.
Closing Costs
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Points paid for refinancing a home may be deducted since the IRS defines points as pre-paid interest charges. This applies to origination and discount points. The IRS treats points differently on purchase money mortgages than refinance mortgages. Points paid to purchase the home are deductible in the same year the loan closes. Points from a refinance are deductible over the term of the loan. If your loan is for 15 years, then you must deduct 1/15th of the points each year. The one exception is the amount of the loan used to fix or improve the home. If you borrow $200,000 and use $50,000 of the loan for home improvements, you may deduct 25 percent of the points that year and the remainder over the term of the loan.
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Mortgage insurance
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As of 2011, the IRS allows deduction of mortgage insurance premiums. If your current loan does not require mortgage insurance but your new loan does, this may mean an added deduction. The rules to deduct mortgage insurance are different from the rules to deduct mortgage interest. Do not presume you may deduct mortgage insurance just because you can deduct the interest.
Basic Requirements
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It's always wise to ask a CPA to review your taxes if you do not have one prepare them. Mortgage interest deduction requires the mortgage balances not exceed $1 million. Mortgage points are only deductable on your primary home, they cannot have been financed or included in the loan amount (even on a refinance), must be expressed as a percentage and be common in your area. Mortgage insurance deduction requires the borrowers' income not exceed $100,000. Other limitations may apply, and these topics are covered in detail on the IRS website (see Resources).
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