What are the Tax Consequences of Refinancing a Mortgage

First off, a mortgage is a method of using personal property as security for the payment of the debt. Like collateral. Only your collateral is the thing you initially had the mortgage for.

The term mortgage, derived from French legal language meaning ‘dead pledge’, refers to the legal device used for this purpose, but it is also commonly used to refer to the debt secured by the mortgage, the mortgage loan.

Unfortunately there are some down sides to refinancing. Many pros. Many cons. Luckily I am only here to mention the cons and further caution you as to your next step in your financial future.

Say you’re mortgage is for $300,000.00 and your interest is at 8%. Refinancing to an interest of 6% would save you money, but at the end of the year you get less from your taxes. Your interest rate is tax deductible. Therefore refinancing though you get many benefits, it still has some consequences. Refinancing by getting a new loan to pay off the old loan of equal value faces first-mortgage restrictions.

Such restrictions are explained in depth by your adviser.

Depending on your tax bracket, if you’re losing $100 worth of deductions because of the refinancing, that would mean you would owe an additional $15 in tax at the 15 percent bracket. That’s kind of a good rule of thumb.

Interest paid on a home mortgage is usually tax deductible for those that itemize their deductions. Consult your adviser for more information. Your adviser may be able to give you in depth details of what all could go wrong.

So say the IRS lets you deduct 100% of the interest you pay on one or more home mortgages, up to a total loan value of $1 million. When you refinance and withdraw cash, the rules change. Only the interest on your original mortgage balance, plus an additional $100,000, qualifies for a deduction.

Here’s how the tax trap works, excuse my apology but it does work like a trap. Let’s say you borrowed $600,000 at 8% in 1992 to buy your house. By 1997, the house had appreciated substantially and the mortgage balance had been whittled down to $550,000. Then you refinanced, taking a new loan of $750,000 at 6%. At tax time, Form 1098 would show that you forked over about $49,000 in interest on the $750,000 mortgage in 1997.

Caution: Refinancing of an acquisition debt is considered acquisition debt to the extent it does not exceed the principal outstanding on the loan immediately before the refinancing.

So now you know a big con for refinancing a mortgage. There really are some upsides as well, don’t exclude the idea of refinancing. There are always down sides to every financial decision you make. Which is why you prepare yourself. Know the facts. Be cautioned and ready for anything.