Home ownership has its privileges, or at least its opportunities. Tax deductions as well as the ability to refinance a loan to tap equity or reduce one’s monthly payments are two examples. Did you know that refinancing points could have tax deductions?
Similar to a purchase mortgage, a refinance mortgage may require a borrower to pay points as part of the closing costs of the loan. The option to pay refinancing points or not to pay refinancing points could be left to the borrower to decide, and there are tax advantages and disadvantages to each.
We’ll take a look at the pros and cons paying refi points, but before we do, let’s make sure we understand what they are.
What’s the point?
One “point” equals 1 percent of the total refinance mortgage amount, so on a $200,000 loan with two points, the borrower would have to pay $4,000 in fees.
For the purposes of tax deductions, there are two types of refinance points:
- Origination points
- Discount points
Origination points are added to closing costs to help pay for the lender’s loan expenses. Discount points are added to closing costs as a trade-off to help the borrower get a lower interest rate. In short, by agreeing to pay more up front for a loan, through refinance points at closing, a borrower receives better loan terms in the form of a lower interest rate. With a lower rate, the borrower ends up with a more affordable monthly payment.
Did you know that refinancing points could be tax deductible? (Photo/ReMax)
Can you get refinance tax deductions?
All homeowners refinancing their home are looking for every mortgage refinance tax deduction they can get (at least the wise ones are). So, upon understanding what refinance points are, the question becomes: “Are refinance points tax deductible?” And the answer is yes and no.
Yes, refinance points are tax deductible. But no, they are not deductible in full for the year paid. You will need to remember to spread the deduction over the life of the loan. Accountants call this process “amortization.”
Let’s use the above $200,000 mortgage with $4,000 in points as an example. If it is a 30-year loan, you would divide the $4,000 in points by 30 to get your annual deduction of $133.33.
Getting your refinance mortgage tax deduction faster
There are a couple ways to accelerate the tax deduction process in your favor if you decide to pay refinance points.
- Paying off your loan balance in full and early
- Refinancing your mortgage a second time (assuming you were paying points on the first refi)
Realize that the deduction applies to the year of termination of your “existing” refinance mortgage and that the tax deduction applies only to the remaining points balance. There’s a reason tax accountants exist, so if you have questions, use one.
Another way to accelerate your tax deduction is to take out a cash-out refinancing loan. This type of loan requires homeowners to have some level of equity in their property beyond what they still owe on the loan. For instance, if a home is worth $200,000, and a homeowner still owes $150,000 to the lender, their equity is $50,000. If the homeowner does a cash-out refi, the lender will create a new loan for $200,000 and give $50,000 cash to the borrower.
Cash-out refinancing is popular with homeowners looking to do home improvement to add value to their property or those looking to pay down other debts. Any portion of the points that relate to the home improvement costs can be deducted up front. For example, if you spent $50,000 of the $200,000 refinance that we’ve been using as an example on an addition, you’d be able to write off $1,000 of your $3,000 in points in the first year. The remaining $3,000 would get spread over 30 years at $100 per year.
One more exception to the tax deduction rule is if you refinance your home in conjunction with the purchase of a new home, or with making improvements on the home that is being refinanced. In these cases, you may be able to deduct up to all of the refinance points paid on the same year’s taxes.
What does this mean for your refinance?
If you can afford to pay more up front in closing costs, then refinance points are an excellent way to save yourself money over the long-term. If you cannot afford to pay more up front in closing costs, then finding a refinance mortgage that allows the option of not paying points is one way to save money now, in the short run.
For some people, that means the difference between being able to refinance their home mortgage now, and not being able to. Generally speaking, paying points is an excellent idea if you will be staying in your home and keeping your mortgage for more than seven years. Taking out a no-points loan makes more sense if you plan to sell or refinance your home in a relatively short period of time.
What other tax benefits are homeowners eligible for?
Remember, there are many ways a home can benefit you come tax time. The interest you pay on your original loan or refi is tax deductible. Home improvements, especially energy-saving improvements, also carry tax benefits.
Whatever you do, the first step in taking advantage of the interest and tax savings that a refinance loan can bring you is to talk to a lender or mortgage broker. Once you get your refinance in process, work with a tax professional to make sure that you get every penny of tax savings that you can.