How Does Refinancing Affect Taxes

What You Need To Know About Refinancing Your Home

Refinancing a home is one of the most difficult aspects that must be understood. In a cash-out refinance, you do not pay income taxes on the money you receive. Heres everything you need to know about a cash-out refinance loan, including how to qualify, what the tax implications are, and the risks of getting one. The IRS allows you to deduct certain costs when refinancing a home, such as mortgage interest, but only if you itemize deductions. If you take the standard deduction , you wont have to pay taxes on your mortgage refinance. In addition to the payment of an escrow account, you may be required to make another payment when refinancing a home. When a transaction is closed, a holding account is set up in the buyers name to cover the costs. When a refinance results in equity below 20%, the loan-to-value ratio exceeds 80%, necessitating an escrow account. LTV is an abbreviation for loan-to-value, which compares the loan balance to the appraised value of the house.

Does Refinancing Your Home Affect Your Tax Return

Asked by: Otis McLaughlin

Refinance loans are treated like other mortgage loans when it comes to your taxes. You may be able to deduct certain costs, like mortgage interest, but only if you itemize your deductions. If you take the standard deduction , then your mortgage refinance won’t affect your taxes one way or another.

How We Make Money

You have money questions. Bankrate has answers. Our experts have been helping you master your money for over four decades. We continually strive to provide consumers with the expert advice and tools needed to succeed throughout lifes financial journey.

Bankrate follows a strict editorial policy, so you can trust that our content is honest and accurate. Our award-winning editors and reporters create honest and accurate content to help you make the right financial decisions. The content created by our editorial staff is objective, factual, and not influenced by our advertisers.

Were transparent about how we are able to bring quality content, competitive rates, and useful tools to you by explaining how we make money.

Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and, services, or by you clicking on certain links posted on our site. Therefore, this compensation may impact how, where and in what order products appear within listing categories. Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range can also impact how and where products appear on this site. While we strive to provide a wide range offers, Bankrate does not include information about every financial or credit product or service.

You May Like: How Much Do Llc Pay In Taxes

Limits To The Mortgage Interest Deduction With A Cash

You cannot deduct the interest on the entire new mortgage if you use the cash out for anything other than a capital improvement. That includes paying off credit card debt or buying a new car. In these cases, youd only be able to deduct the interest on the original mortgage balance.

Lets say you have a mortgage with a $60,000 principal, and you want to take out $20,000 in equity through a cash-out refinance. If you use the cash to add a hot tub to your backyard, you can deduct the interest you paid on the total balance, or $80,000. If you use it to pay off your credit card debt, you can only deduct the interest you paid on only your original balance, or $60,000.

Even so, using a cash-out refinance to pay off credit card debt can still be a smart financial decision if youre burdened by high-interest debt. Most credit cards charge double-digit interest rates, while mortgage interest has been in the 3 percent range since the start of the pandemic.

In 2018, some of the deduction limits changed. The simplified version of the current regulation: You can deduct interest on up to a $375,000 mortgage if youre single or married filing separately, or on up to a $750,000 mortgage if youre married filing jointly.

If you purchased your home before the new limits went into effect, you will still be able to deduct interest payments on a higher balance, but that higher limit will not include any of your cashed-out funds.

Is A Cash Out Refinance Taxable

Since a home isnt actually being sold with a cash out refinance, the IRS doesnt consider the cash generated as income or as a capital gain. A cash out refinance is more similar to taking out a loan, because in order to pull cash out of a home with a refi the mortgage balance and loan payments increase.

The following example illustrates how the monthly principal and interest payments on a mortgage might change with a cash out refinance, assuming that the interest rate remains the same:

A cash out refinance isnt a taxable event. However, refinancing a rental property to pull cash out does have an impact on the financial performance of an investment and on the pre-tax income the property generates.

Also Check: How Are Crypto Gains Taxed

Tax Implications On The Second Mortgage

Suppose you opt for a second mortgage ) instead of a cash refinance. Are you still able to deduct mortgage interest?

Again, it depends on what you are using the funds for. If youâre buying or significantly improving a home, you probably can. But, if youâre borrowing for other purposes , you definitely wonât.

The IRS Post 936 â Homepage Mortgage interest Deduction give all the details.

Is It A Good Idea To Do A Cash

In order to make the most of a cash-out refinance option, think through the following first:

• First, assess how youre going to use the cash from the refinance.
• Then, depending on the goal, ascertain if a cash-out refinance is truly the best fit. Other products, like a personal loan or student loan refinance, may make more sense if debt consolidation is the ultimate goal.
• Visit an online marketplace like Credible to review refinance rates and shop interest rates with multiple lenders in one spot.

If youve got a substantial amount of equity in your home, it may feel like a pretty sweet deal to be able to turn that asset into cash with just a small amount of paperwork. As with most financial decisions, however, its best to leverage refinance calculators to do the math and ensure the money moves actually improve your financial life, before signing on the dotted line.

Also Check: When Is Taxes Due This Year

Deducting Mortgage Points On A Cash

Also called discount points, mortgage points are essentially upfront fees you pay a lender in return for a lower interest rate on your loan. One point equals 1 percent of your mortgage loan.

With a cash-out refinance, you cannot deduct the total amount of money you paid for points during the year you did the refinance, but you can take smaller deductions throughout the life of the loan. So if you purchase $2,000 worth of mortgage points on a 15-year refinance, for instance, you can deduct about $133.33 per year for the duration of the loan.

Paying Property Taxes And Other Costs When Refinancing

Refinancing will feel fairly similar to when you closed your first mortgage, and you might need to consider how to budget for property taxes and homeowners insurance in your closing costs this time around, too.

Depending on when the loan closes, borrowers could be required to pay property taxes through escrow, Greene-Lewis says.

This will vary based on where you live. For example, in Illinois, property taxes are typically due on June 1 and September 1. In Arizona, the due dates for installments are November 1 and March 1.

As you prepare to set aside money for your refinance closing costs, youll need to determine if your current lender has already made your property tax payment. Review your escrow transaction history to see if your lender has paid the bill, or ask the lender for proof of payment. You can also verify payment with your local tax authority. If youre switching lenders, make sure the new lender has a record that your property taxes have been paid to avoid a larger-than-necessary set of closing costs.

For homeowners insurance, youll likely need to update your policy if the appraised value of your home has changed. If youre refinancing your mortgage with a new lender, youll need to update your policy with that lenders information.

Don’t Miss: Can You Get The Child Tax Credit With No Income

Does Refinancing Affect Taxes

Unfortunately, theres no cut-and-dry answer here. Refinancing may or may not affect your taxes, depending on what type of refinance you used and how you file.

As a general rule, your mortgage only impacts your taxes if you itemize your deductions.

And, if you used a straightforward rate-and-term refinance, there likely arent any tax implications. A cash-out refinance could have some, but you will not have to pay income tax on the equity you cashed out. Heres what you should know.

The Mortgage Reports is not a tax site. This information is for general guidance only. Consult with a tax professional about your specific situation.

In this article

• Potential tax deductions

Get A Comprehensive Plan For Your Student Loans

Taxes are just one piece of the student loan puzzle youll want to consider when comparing refinancing options against other student loan repayment approaches like IDR or pursuing loan forgiveness.

Your income, where you work and even your marital status could impact your tax and loan repayment strategies. For example, if qualify to join the Public Service Loan Forgiveness program, refinancing your federal loans could be a costly mistake.

Speaking of refinancing federal loans, there are a number of other benefits that youd give up by doing so. For one, youll no longer qualify for federal forbearance or deferment. Youll no longer have the ability to join income-driven repayment plans either.

Our Student Loan Planner® advisors are experts in helping borrowers create cost-saving strategies for student loans and income tax. Theyve helped thousands of borrowers build the right student loan plan to save more money. And theyd love to help you too. Book a student loan consultation today.

1 Disclosures2 Disclosures3 Disclosures4 Disclosures6 Disclosures7 Disclosures8 Disclosures

Take our 11 question quiz to get a personalized recommendation of whether you should pursue PSLF, IDR forgiveness, or refinancing .

Filed Under: Personal Finance, Refinance Student Loans

About Clint Proctor

You May Like: Do You Have To Pay Taxes On Home Equity

Cash Refinancing Tax Implications

Letâs start by dispelling a common misconception. You do not pay taxes on the amount you have borroweduse cash refinance. The Internal Revenue Service considers the money from your refinance a loan rather than taxable income. You will therefore not pay income tax.

You donât pay income tax when you borrow to buy a car or when you take out other types of loans because the value you receive is not income. It must be repaid with interest. And the same goes for a cash refinance.

For the full story you should download and read Post 936 â Homepage Mortgage interest Deduction from IRS website and check for updates here.

But here is a general overview of the tax rules that generally apply to cash-in refinances for those detailing the deductions.

Pro #: You May Lower Your Current Mortgage Interest Rate

Typically, this is the main motivator behind refinancing. If you originally got your mortgage when interest rates were high, and youve never refinanced, you may be paying more than you need to. Taking the time to apply for a new loan at a lower rate could save you hundreds of dollars a month.

For example, if you have a $200,000 loan and are paying 7 percent interest on a 30-year fixed-rate mortgage, your total monthly interest and principal payments are probably about $1,331. If you refinanced at 3.8 percent, your monthly payment could be reduced to $932. Thats a monthly savings of $399!

Read Also: How To Appeal Property Taxes Cook County

Refinance Tax Deductions: What Refinancing Costs Are Deductible And How To Claim Them

The Tax Cuts and Jobs Act of 2017 had several implications for refinancing. Understanding the new tax rules can help you minimize your tax burden after you refinance your house. In this article, well talk about some of the deductions you can claim on your federal taxes after a refinance, and how long you can claim them.

Standard Vs Itemized Deductions: What You Need To Know

The TCJA tax reform doubled the standard deduction for taxpayers. Your filing status determines the minimum amount of deductions you need to claim itemized deductions on Schedule A of your Form 1040 federal tax return.

Here are the standard deduction amounts for the 2021 tax year:

In addition to qualifying mortgage expenses, some of the itemizable deductions include:

• Charitable contributions
• Medical and dental expenses
• State and local income, sales, and property taxes

For example:$30,000 total deduction $25,100 standard deduction = $4,900 itemized deduction

However, youll need to claim the standard deduction if your itemized deductions dont exceed the standard deduction amount for your filing status.

You May Like: Is Health Insurance Tax Deductible

How To Use Your Cash

There are plenty of home improvement projects you can tackle with your cash out in order to claim the mortgage interest deduction. Here are some examples:

• Adding a swimming pool or hot tub to your backyard
• Constructing a new bedroom or bathroom
• Erecting a fence around your home
• Enhancing your roof to make it more effective in protecting against the elements
• Upgrading windows
• Setting up a central air conditioning or heating system
• Installing a home security system

Keep in mind that capital improvements are generally defined as permanent additions that increase the value of your home. Repairs like fixing a broken window or small design changes like painting a room dont usually count.

Capital improvements must substantially improve your home, explains Dennis Brager, a certified tax specialist with Los Angeles-based Brager Tax Law Group. Kitchen and bathroom remodels, room additions, modifications for an elderly parent would all qualify. A standalone painting would not qualify on the other hand, if it was just part of a larger remodel, then the cost of the paint job would qualify.

Commonbond Disclosures: Private In

Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC , NMLS Consumer Access . If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. If you choose to complete an application, we will conduct a hard credit pull, which may affect your credit score. All Annual Percentage Rates displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.15% effective Jan 1, 2021 and may increase after consummation.

Don’t Miss: What If I File My Taxes 1 Day Late

How Refinancing Can Create Tax Deductions

In the past, one of the key benefits of home loan products such as a home equity line of credit , home equity loan, or refinance was that you were allowed to take a tax deduction on the interest you paid, regardless of how the money was used. In other words, the IRS allowed you to get back some of the money you paid out on your tax return. However, the rules regarding home loan interest deductions changed in 2017. Now, you can only get tax deductions under certain circumstances.

Heres what you may be able to deduct when you arrange a cash-out refinance.

Can I Write Off Points On A Refinance

You can deduct points paid for refinancing generally only over the life of the new mortgage. … You can deduct the rest of the points over the life of the loan. Points charged for specific services, such as preparation costs for a mortgage note, appraisal fees, or notary fees aren’t interest and can’t be deducted.

Don’t Miss: How To File Llc Taxes On Turbotax

Rental Property Closing Costs

At a glance: Closing costs for rental properties can be tax-deductible unlike for a personal residence.

Most rental property closing costs are tax-deductible on Schedule E and dont require filing an itemized return.

Some of the eligible costs include:

• Title insurance

However, some expenses cannot be deducted when you refinance your rental property. One example is mortgage points when the loan amount is larger than the original balance.

For instance, if you took out a cash-out refinance on an investment property that appreciated in value, any portion of the points that exceeds the original loan balance cant be deducted as a rental expense.

Con #: You May Not Be Able To Deduct Your Entire Mortgage Interest Expense After Refinancing

If you refinance your home for the same amount you already owed on your mortgage, you can keep taking a mortgage interest deduction as always. The same applies if you take out a slightly larger loan to pay off some bills. As long as you itemize deductions on your tax return, you generally can deduct your total mortgage interest expense.

However, your deduction may be limited if you refinance and get a substantial amount of cash back. When you refinance, any money you receive in excess of your previous mortgage amount is called home equity debt. You can only deduct your home equity debt interest on a balance of up to $100,000 .

You May Like: How Much Do I Need To Make To Pay Taxes