Planning to refinance your mortgage in the upcoming year? Be sure to schedule some big savings when it comes time to do your 2011 taxes.
When most homeowners consider the savings that will result from a mortgage refinance, they don't take into account the tax savings. They usually just figure out the "break even" point, or the number of months that it will take for the monthly savings to add up to the cost of the refinance.
While figuring out the "break even" point can give you a good, general idea of whether a refinance is worth it to you, it's not the whole picture. Potential refinancers seem to stick to that calculation because it's relatively easy math to do.
Determining the tax benefits of a refinance is much trickier - and may require the help of an accountant-but just as important, if not more.
Here are four ways that your taxes can benefit from a refinance:
1) General tax benefits
With a refinance, you are generally going to be able to deduct more money off of your taxes right off the bat.
As you probably know, for the most part, mortgage interest is completely tax deductible. At the beginning of a mortgage, you are paying more for the interest than you are for the principal. With a refinance you will automatically have a lower tax liability-the amount that you owe- because it is a new loan and you will be paying more interest in those first years.
2) Home Acquisition Debt:
When refinancing your mortgage, there are two kinds of debt that you can acquire as far as the IRS is concerned. The first is home acquisition debt, which is the amount that is used to pay off your old mortgage. For the most part, homeowners are allowed to deduct any interest paid towards this home acquisition debt.
3) Home Equity Debt:
In the eyes of the IRS, the second type of debt that you can rack up in a refinance is home equity debt. This is the amount of your loan that is in excess of what was necessary to pay off your old mortgage. Interest on home equity debt is generally only deductible for the first $100,000 if it is for credit card debt, purchases, or a vacation and up to $1million if it is used for home renovations.
You were probably able to deduct the money that you spent on points from your first mortgage. Deducting the cost of points for a refinance is trickier. Instead of deducting all of the cost of points at once, you have to spread out the deductions out over the life of the loan. So, if you have a 20-year mortgage, you can only deduct 1/20th of the cost of the points per year.
That is, unless you sell or refinance again, at which point you will be able to fully take advantage of the unused fraction of points.
A mortgage refinance can have a big influence on your finances, especially on your taxes. If you are considering going through the refinance process, be sure to stop by your accountant's office before you get started to figure out the best way to take advantage of the tax benefits available to you.