When you first bought your house, you were probably able to take advantage of some tax deductions. Now that you are refinancing, though, do those same deductions apply to you? Are you able to write off some of the closing costs you pay this time around?
Writing Off Closing Costs
When you refinance your mortgage, you typically don’t have to bring money to the table with the exception of the cost of the closing costs. In other words, you don’t need a down payment. You already put the money down on the home. Now it’s a part of your equity. That’s already figured into your new loan, as the refinance is just your new lender paying off your existing loan.
Chances are that you will need some cash to close, though. Most lenders will charge fees unless you opted for a no-closing-cost loan. If that’s the case, then you pay the costs in your interest rate. If you opt to pay the costs and take the lower interest rate, you could be looking at paying as much as 5% of the loan amount at the closing. On a $200,000 loan, that could mean $10,000. It would be nice if you could write those fees off.
Unfortunately, there isn’t a deduction for a majority of your closing costs. Things like underwriting, processing, appraisal fees, and closing fees are not deductible. You have to pay the fees to close your loan and they will not lower your tax liability.
Writing off Points
There is some good news, though. If you pay points on your mortgage, they may be deductible. You may see the points named origination fee, discount points, or a loan discount. No matter what it’s called, the lender charges you a percentage of your loan amount. One point equals one percent of your loan. On the $200,000 loan, one point is $2,000. Usually in exchange for this point, the lender gives you a slightly lower interest rate. Typically, one point lowers your rate 1/8th of a percent.
Lenders look at points as prepaid interest. You pay the interest upfront or at the closing rather than over the life of the loan. Because you can write off your mortgage interest on your taxes, you can also write off the points you pay. But before you get too excited and write off the full amount that you paid, there’s one more thing you must know – you must spread the points out over the life of the loan. That $2,000 point must get spread out over the 15 or 30-year term that you refinanced.
Writing off your points won’t put a huge dent in your tax liability, but it’s better than nothing!
The Items you Can Deduct
Aside from the points you can write off on your loan, you can also write off a few other things:
- Mortgage interest paid – Any additional mortgage interest you pay at the closing per your settlement statement
- Real estate taxes paid – If you paid any real estate taxes at the closing, you can write them off
You’ll see each of these things listed on your Settlement Statement. This statement shows the total cost of your loan and how much cash you must bring to the closing. You will use this statement to do your taxes, so make sure you save it.
The Important Details
Before you deduct any points, interest, or real estate taxes on your income taxes, make sure you meet the following requirements:
- The home must be your primary residence
- The refinance must use your primary residence as collateral
- You itemize your tax deductions
If you meet these requirements, you may be able to take a few deductions and lower your tax liability a little bit. Real estate taxes and mortgage interest usually give you the largest deductions out of all closing costs. Remember, you can also write off the mortgage interest you paid on your old loan before you paid it in full as well as any real estate taxes you paid all year, not just at the closing. That will help to lower your tax liability even further.
Refinancing can save you money, but the closing costs can add up if you aren’t careful. Make sure that before you agree to refinance that you figure out your break-even point. At what point do you start reaping the savings of the refinance (after paying off the closing costs)? Let’s say it takes you 5 years to pay off the costs the lender charges, will you still be in the home for a few years after that? If you won’t, refinancing might not make sense. Talk with your lender about the break-even point and about keeping the costs to a minimum to help you get the most out of refinancing.