Mortgage Refinance - Tax Deductions and Points

By paying a little more in upfront closing costs, you may save significant amounts of money on long-term interest. As an added bonus, the IRS lets you claim the points as a deduction. However, homeowners should know that points paid on purchases and points paid on a mortgage refinancing are treated differently

Homeowners hesitant to spend money on long-term interest often pay points on their mortgages. (A point is an interest charge paid upfront when you close your loan. It equals 1 percent of the total loan amount.) But such hesitancy is not always necessary, because when points are paid, it usually results in lowering your mortgage interest rate.

The IRS has blessed homeowners by letting them deduct points on their taxes. However, there's a subtle difference between the amount deductible on a mortgage refinance versus the amount you can claim on a traditional home mortgage.

Refinancing taxes made easy

When you purchase your home, you'll jump for joy knowing that the points you'll pay are deductible in the tax-year in which you made the buy. For example, if you paid one point on the origination fee of your brand new $350,000 house, you'll have a hefty $3,500 tax deduction to write-off when April 15th comes around.

It's a different ballgame, however, when you refinance your mortgage. In the above case, if the same homeowner refinances his mortgage after two years, the deduction for the amount he paid in points will be amortized over the course of the loan. If he refinances and pays 2 points on a new $300,000 loan, his tax deduction of $6,000 under the refinancing scenario-(2 percent x $300,000)-would be amortized over 30 years (the term of the new loan). The math in this case ($6,000/30) results in a tax deduction of $200 per year for 30 years.

The silver lining

Don't let this IRS stipulation rain on your tax break parade. Uncle Sam won't make you wait 30 years to claim the entire deduction. If you decide to refinance again, or if you sell the house, you can write-off the unclaimed portion of the deduction. In the above example, if the homeowner decides to sell his house after only two years after refinancing his mortgage, he can claim the remaining $5,600, since he had deducted only two years at $200 on his taxes.

Paying points on a home loan can be a great move for people who don't plan on moving. Just be aware that the tax deduction on a mortgage refinance won't be as immediate as a purchase loan. One way or the other, though, you'll get the deduction. As is usually the case with most things monetary, it's just a matter of time.

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