What to Consider When Refinancing: Tax Cost

There can be some significant benefits that are associated with home mortgage refinancing. There are also some other factors that you do need to keep in mind when it comes to home mortgage refinancing. You need to weigh and balance the costs and benefits associated with home mortgage refinancing.

In this article, you will be presented with some information pertaining to the tax cost and related implications of home mortgage refinancing.

How Does the Tax Deduction Work in the First Instance

To understand your tax costs in refinancing, let’s review how the tax deductions work on interest payments and mortgages in the first place. Remember that paying a mortgage is perhaps the best way to reduce your tax bill through deductions. The current tax codes provide for deductions on interest paid on first and second homes as long as the total loans are less than $1.1 million.

Weighing and Balancing the Tax Impact of Home Mortgage Refinancing

This information may seriously affect the loan product you choose. If your increase in taxes overshadows your savings on your monthly payments, there is really little reason to refinance. It’s known for that reason that a 30-year mortgage has a better deduction than a 15-year mortgage, and the tax deductions are generally better.

An Example for Your Consideration

For instance, for a $150,000 loan amount at 6.5% (and tax rate of 25%, along with other factors being equal) will have a tax savings of $3,472 on a $30-year fixed rate loan the first year, but only $3,432 per year on the 15-year loan. While this is only a $40 change, the higher the loan amount the larger the difference; always check and make sure it will benefit you to refinance. If you are only staying in the house a few years, ask your loan representative to compare these figures to the interest only loan and the ARM.

The Tax Consequences -- Money You Will Save

Most of the time, however, the tax will appear in the form of savings. Only occasionally will you see taxes increasing beyond the benefits of refinancing. Even the points you use to pay down your interest rate are deductible because they are related to paying interest, according to the IRS. Remember that a point is 1% of your loan principal, and some mortgage brokers let you add it to the loan amount. That means you are adding interest payments, but you will also be able to use it as a deduction over the life of the loan. If you pay the points up front, you can take the deduction for that tax year.

Conclusion and Summary

Make sure you know how your payments will affect your taxes, and do what will work best for your situation. If you have any doubt or are not clear on what your loan representative has told you, speak with a tax consultant.