Should You Consider Refinance Cash Proceeds
Many people wonder whether refinance cash proceeds are worth the hassle or if they should obtain the money they need in some other way. The bottom line is that it depends on your exact situation. Avoiding additional taxation, however, is a huge benefit that many borrowers could benefit from. If you obtained money in any other way, aside from another type of loan, you would more than likely pay taxes on the proceeds. The money you receive from your mortgage, however, will not get taxed and could save you money on your tax liabilities based on the amount of interest you pay.
You should always talk to your tax professional before making any financial decisions including those that pertain to your home. He knows your exact situation and how it will affect you. In general, though, cash-out refinances do not hurt an individuals tax liability, no matter how much they take out of their home.
When You Refinance Your House Is The Cash Back Taxed
You can tap into the equity you’ve built in your home with a cash-out refinance. With a cash-out refinance, you borrow more than you owe on your current mortgage and receive the excess in cash. However, though you’re still using your home as collateral, that doesn’t mean that you can automatically continue to claim all the interest you pay as part of the mortgage interest deduction.
To Take Care Of Other Big Expenses
The third major reason to refinance has less to do with your investment strategy than your personal life. However, it’s still important to mention. Sometimes life comes along with big expenses like education costs or medical debt. If you have to cover a big expense in the near future, doing a cash-out refi may be a smart way to get the funds you need at a lower interest rate than a personal loan or a private money lender.
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Any Improvements Made To A Rental Property
You might use the money from a cash-out refinance to improve or repair a rental property and can deduct these expenses from your federal taxes. Any improvements or repairs you make to a property you rent out are almost always tax deductible. This is because the IRS considers any money you earn from rent as personal income. You can also deduct closing costs, interest and insurance you pay on a rental property from your income as business expenses.
Tax Deductions And Refinancing
The IRS allows you to deduct the interest paid on up to $1 million in mortgage debt, on either your primary or secondary home, or the two combined. So if you have a $750,000 mortgage on your primary home and $250,000 mortgage on a vacation home, you can deduct all your mortgage interest.
That doesn’t change after refinancing, so you can refinance one or both mortgages and still deduct all your mortgage interest, as long as the combined mortgage principle does not exceed $1 million for a couple, or $500,000 for a single filer.
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Cash Out Equity To Invest
Its a common theme in my writing to point out the advantages of borrowing money to invest. In real estate investing, the power of property appreciation is amplified several times over when you leverage your money and take out a loan to invest.
The same is true for almost every other type of investing. At its simplest, we can see that investing in something like the stock market, that gets 8-12% ROI, will be profitable if you buy the stocks with a 4-6% loan.
When the investment outperforms the interest on the loan, you win.
And getting that 4-6% loan can be difficult depending on your financial situation. So we, as investors, must often get creative to find that money.
When you cant get a traditional mortgage, you may borrow from your 401k or call up hard money lenders.
Or you can cash out on the equity you have in real estate you own, even the house you live in.
The Numbers After A Cash Out Refi
Current rules allow for a 75% loan to value ratio on a cash out refinance.
So you would be starting a new 30 year mortgage with an $83k balance.
You get a new loan for $83k and you owe $53k on the original loan. So you pocket $30k minus the costs of doing the refi, which may be around $4k.
$26k tax free!
Your mortgage payment will go up slightly, but if you have been able to successfully raise the rents, the tenant will still pay it. You wouldnt do a cash out refinance unless you can still get monthly cashflow on the property.
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How The Federal Reserve’s Fomc Supported The Real Estate Market & Economy
- Emergency Rate Cut: On March 3, 2020 the Federal Reserve’s Federal Open Market Committee held an emergency meeting where the Federal Funds Rate was lowered a half percent to the range of 1 percent to 1.25 percent.
- Additional Rate Cut: On March 15 the FOMC lowered the Fed Funds rate to 0 percent to 0.25 percent.
- Forward Guidance: They later issued forward guidance stating they anticipate low rates will last through 2023.
- Quantitative Easing: On March 23 the Federal Reserved announced the FMOC will purchase an unlimited amount of Treasury securities and mortgage-backed securities to ensure smooth market functioning.
The FOMC market intervention along with a crash in the stock market & lowered inflation expectation has caused mortgage rates to reach historical record lows, which has caused real estate prices to hold up well and what will likely be a record year for mortgage originations. Black Knight’s Ben Graboske stated: Nearly $1.1 trillion in first lien mortgages were originated in Q2 2020, which is the largest quarterly origination volume weve seen since first reporting on the metric in January 2000.
2020 a Record Year For Mortgage Lending
On September 15, 2020 Fannie Mae forcasted a record $3.87 trillion year for mortgage lending with $1.4 trillion in home sales and $2.4 trillion of loan volume being from refinancings.
What Is A Cashout Refinance
A cashout refinance lets you access your home equity and refinance your mortgage at the same time.
When you use a cashout refinance, your new loan will be larger than what you currently owe on the home.
With the new loan, youll pay off the old loan and then keep the additional cash you didnt need to pay off the old loan.
The lump sum you keep is your cash out, and you can spend it on a variety of financial needs.
A few important notes on cashout refinancing:
- Cashout refinance rates are slightly higher than traditional mortgage refinance rates
- Your refinance rate depends on your credit profile and how much cash you take out
- You can typically cash out up to 80% of your home equity
- Your new loan will be larger than your old one, so youll pay more in mortgage interest in the long run
- Since mortgage rates tend to be lower than personal loan or credit card rates, cashout refinancing can be a better way to finance larger expenses
There are no rules about how you can or cant use the funds from a cashout refinance.
These additional funds can be used for many purposes, including home improvements, consolidating debt, and other consumer needs or wants, says Tom Trott, branch manager at Embrace Home Loans.
But because the loan is secured by your home, you typically want to spend your funds on something with a good return on investment like home renovations or consolidating higherinterest debt.
See a few more good examples of how to use a cashout refinance here.
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Alternatives To A Cash
The primary reason anyone considers a cash-out refinance is to raise cash relatively quickly. Whether it is for pleasure or investment, a cash-out refi provides an opportunity to access some much needed cash at interest rates that may be more forgiving than a personal loan, credit card advance, or even a home equity line of credit. Of course, there are some alternatives to cash-out refinancing that allow consumers to raise some much needed cash without putting their homes or investment properties at risk. We would be remiss if we didn’t spend at least a little time talking about those alternatives, and how they compare to cash-out refinancing.
How A Cashout Refinance Affects Your Taxes
Borrowers may qualify for mortgage interest tax deductions, provided that funds from the cashout refinance are being used for property improvements. Some examples of home improvements that are eligible for mortgage interest tax deductions could be:
- New additions to a home
- Home security installation
- Roofing repairs
Disclaimer: TheMortgageReports does not offer tax advice on this site. Please consult with a tax advisor about your situation before making any decisions about how a cashout refinance affects your taxes.
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Other Limits To Mortgage Interest Deductions
You can only deduct the interest you paid on the first $750,000 if you are married filing jointly, and $375,000 if married filing separately. This rule applies to any loan used to buy, build, or improve the home.
Note that a cash-out refi replaces your old mortgage with a new, bigger one. It is not free cash. You get some of the difference between your current loan balance and the value of your home in cash. The new loan includes the amount you got in cash as well as closing costs. So it could go over the maximum you can claim under new tax laws.
The good news is you can deduct all of the mortgage interest on the original loan balance, even if it is over the limit. So, if you have An $800,000 home loan balance, take out $20,000 and use it for a new kitchen, you are allowed to deduct the interest on the $800,000, even though it goes over the $750,000 limit.
But you are not allowed to deduct the interest on the $820,000 because it is over the limit, even though you used it on a capital improvement.
How Do Tax Laws Affect Cash
Its important that we go over exactly how cash-out refinances work before we look at how the IRS views the money you get from this transaction. Basically, you replace your existing mortgage with a loan that has a higher principal balance. Your lender then gives you the difference in cash. You can use the money from a cash-out refinance for almost anything. Many homeowners use it to consolidate debt or make home improvements.
Lets look at an example. Say you have $100,000 left on your mortgage loan and you want to do $30,000 worth of repairs. Your lender might offer a new loan worth $130,000 at 4% APR. You take the refinance and your lender gives you $30,000 in cash a few days after closing. You then pay back your new mortgage loan over time, just like your old loan.
One of the first questions that homeowners have when they take a cash-out refinance is whether they need to report it as income when they file their taxes.
As you can see, the cash you get from this kind of refinance isnt free money. Its a form of debt that you must pay interest on over time. The IRS doesnt view the money you take from a cash-out refinance as income instead, its considered an additional loan. You dont need to include the cash from your refinance as income when you file your taxes.
Protect what’s precious
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What You Should Know
- A cash-out refinance lets you borrow a large amount of money at a low interest rate
- The difference between your refinanced mortgage amount and your old mortgage amount is the additional amount that you are borrowing
- You can borrow up to 80% of your homes value with a cash-out refinance
- Cash-out refinances are usually used for debt consolidation, home improvements and renovations, and investments
- There can be significant penalties for a cash-out refinance that is done before the end of your mortgage term
Do You Pay Taxes On Cash
Do you have equity in your home that you want to tap into for one reason or another? Whether you want the money to fix up your home or to go on a dream vacation, you can do what you want with it its your money.
The main concern many borrowers have, though, is if theyll have to pay taxes on it, since they think its income.
Luckily, you dont have to pay taxes on cash-out refinance proceeds. We help you understand the reasons below.
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The Pros And Cons Of Cash
If you find you need to access a fairly large sum of money in a hurry, cash-out refinancing may be the answer. Certainly, it offers some advantages over other forms of debt. Still, while the benefits may be clear, there are some very real disadvantages that all property owners should be aware of before they decide to pursue a cash-out loan.
Think Before Selling The Home
Now, a time when the taxes might catch up to you with the cash-out refinance is when you sell the home. The IRS will tax your capital gains. They first allow you an allowance of $250,000 if you are single or $500,000 for joint filers. Any money you make beyond the respective amount becomes taxable when you sell the home.
The IRS compares the original purchase price of the home to the price you sell it for today. The difference is the capital gains. But you only pay taxes on the amount above and beyond either $250,000 or $500,000. In reality, youll pay these taxes either way, so if you need the money now to enjoy, go for it. Just know that you may owe taxes on the money down the road.
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Deducting The Interest On Your Loan
One area that you may want to be careful when it comes to refinancing and taxes is the interestthat you pay on the loan. This is when the reason for the refinance will play a role in what you owe. Typically, you can write off the interest on a loan when you buy a home. You may even write off the interest on a second mortgage if it was used to buy the home.
When you take out the cash-out refinance, though, things are a little different. You arent taking money to buy a home. Now the IRS wants to know what you did with the money. Did you take it out to reinvest it back in the home? Maybe you added on a room or redid the homes flooring. If thats the case, you can typically write off the interest on the cash-out refinance. But, if you use the funds to consolidate debt, take a vacation, or any other reason that doesnt pertain to your home, you may not be able to write the interest off that you pay.
If You Need To Take Advantage Of Your Equity
Do you need to pay down high-interest credit cards, pay off student loan debt, take a much-needed vacation, or catch up on some home repairs. Using the equity in your home, a cashout refi can convert that equity to money for your immediate needs. Mortgage interest usually at a substantially lower rate than your credit cards and other monthly debts, saving you money. If your property value has increased, a cash-out refi is a popular option. Many times we can get you money out of your home and keep your payment the same or lower than it is now.
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How Does A Cash Out Refinance Work
You need equity in your home to qualify for a cash out refinance. The amount of home equity you need depends on the maximum loan-to-value ratio of the refinance. LTV helps determine whether you qualify for a cash out refinance as well as how much cash you may be able to get. Look at this sample calculation:
|Maximum cash available||$95,000|
In this example, the maximum LTV is 80%. That means the new mortgage balance can be no more than 80% of the value of the home which in this case is $220,000. Because the homeowner in this example has a large amount of home equity, they may be able to refinance and get up to $95,000 in cash.
Many types of cash out refinances, including fha cash out refinances, often have a maximum LTV of 80%. VA loans can have a higher LTV. With a VA cash out refinance, you may qualify for a maximum LTV of 90% which can help you borrow more money.
Regardless of loan type, you will need to complete a new application and provide credit, income, and financial documents to get a cash out refinance. You will often need a new home appraisal to estimate the current value of your home. You will likely pay closing costs. And you will need to review and sign loan disclosures and attend the closing of your new mortgage.
To Finance Home Improvements
One of the biggest reasons that an investor might choose to refinance their current mortgage on an investment property is to do some improvements to the property. Put simply, the more amenities the property has to offer and the more up-to-date it looks, the more rent a landlord can charge for the unit.
With that in mind, if your property has experienced significant wear and tear over the years or simply looks dated, it may be wise to consider investing in a few updates. Consider replacing carpeted areas with hardwood floors or updating the kitchens and bathrooms. Alternatively, you could consider adding air conditioning to the home or investing in an in-unit washer and dryer.
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