Tax Effects of Refinancing
A large amount of factors contribute to whether or not a refinance is going to be a profitable venture for you. For instance, refinancing to a lower rate will mean less tax benefit for you. In some cases, this may make refinancing a poor financial decision. The presence of a mortgage tax may also damage the benefits that a refinance could bring you otherwise. It’s important to take your tax situation into account when you think about refinancing.
If your state levies a tax on home loans, you may have to pay it again when you refinance. Still, there are a number of factors that can affect how much you do or do not pay, not the least of which is individual state tax laws.
- In some cases, if you are refinancing very recently after your initial mortgage, the state may not require you to pay the tax again.
There are legal fees involved, so you would have to weigh these against how much you’ll save on taxes.
When you purchased your initial mortgage, any points you paid on the loan were deductible in that tax year as one, rather large, lump sum. When refinancing, this same deduction is amortized over the period of your loan. For example, if your refinanced loan is for $200,000 and you decide to pay two points up front (2%=$4,000) on a 20-year mortgage, you would end up with a $200 deduction every year for 20 years (rather than a one-time $2,000 deduction). If you decide to sell the home or refinance again, however, you can claim the remaining deductions at once.
Did You Know?
The situation is similar for cash-out refinances. The tax benefits you can receive will be amortized over the period of your loan.
If you itemize deductions on your return, you’ll find that a refinance will inhibit your ability to claim loan insurance on your taxes. If you use the proceeds of your refinance for home improvement, you can deduct the entirety of the insurance, but if you use it for any other reason, there will be restrictions. If you are used to making deductions based on the insurance on your mortgage, you’ll want to factor this into your decision of whether or not a refinance is a good idea.
Each person’s tax situation is going to be different, so ask your accountant about these issues. He or she will be able to look at your individual needs and help you determine the best course of action.