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Mortgage Refinance Tax Implication

Mortgage Refinance and Taxes

When you own your home, you get large income tax deduction for mortgage interest. However, when you refinance your mortgage loan into a lower interest rate, you’ll pay less interest but more income tax.


HAD stands for Home Acquisition Debt and HED stands for Home Equity Debt. HAD is the term used by the IRS for the first or second mortgages that are used to buy, build, or improve your home. You accumulate HAD if you refinance to get either better rates or more favorable terms. On the other hand, if you do a cash-out refinance, the money that is not used for home improvements is considered Home Equity Debt (HED).

Acquisition Debt is fully tax deductible, up to $500,000 for individuals, and $1,000,000 for married couples who file joint returns. The tax deduction limit for Equity Debt is $100,000 more than the existing debt at the time of your refinancing. If you have a mortgage with a balance of $200,000, you can refinance into a $300,000 loan (assuming your home appraises for at least that much now), and still deduct the full interest payments from your taxes. The interest paid on any balance higher than $300,000 is not deductible at all.

You can take out points on your mortgage in order to push down the interest rate even further. Points are generally tax-deductible, like interest payments, except when you’re refinancing.

Some points are charged for lender services and are not tax deductible while others for prepaid interest are deductible. In general, the points are prorated throughout the life of the loan; so if you paid $4,000 in points for your 30-year loan, but $1,000 of that was for services, you can deduct 1/30th of $3,000, which is $100 a year.

However, if you have used part of the refinancing funds for home improvements, you can deduct a portion of the points immediately. For example, if you took a $100,000 mortgage loan, you could pay off an existing $80,000 mortgage and use the rest for home improvements. In this case, you can deduct 20 percent of the points the first year, and spread the remainder throughout the next 29 years.

But, if you refinance again, all points that have not yet been deducted are applied in that one year, regardless of whether the new loan carries any points.

In the final analysis, what you save in terms of interest you pay as taxes when you go in for refinancing your mortgage. Thus, you might want to do a tax code cram session before deciding how to refinance. It is better to know the nitty-gritty of it before you get caught unawares when you file your next tax return.


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