The steadily falling mortgage interest rates of the last couple years are now edging back up. But if you refinanced this year, you probably didn't realize that claiming a bigger interest deduction on your 2003 tax return is possible, even if your overall mortgage payment is less than before.
How? If you refinance, your interest payments in the early years of the loan will constitute a greater percentage of your monthly payment. And, after all, you can only write off the interest, not the principal.
For example, if you're currently paying off a $225,000 mortgage (30 year) and your interest payments are $10,000 a year,
your interest deduction for the first year will increase to $13,500 if you refinance at 6 percent. Tip: If you apply this extra tax savings to prepay your principal, you can also pay off your mortgage quicker.
Here are three other refinancing-related tax tips:
1. Maximize deductions for bigger loans
If you refinance your mortgage for the same amount existing on your current loan, all the interest on the new loan is deductible as acquisition debt. But if you need money to, say, pay your child's college tuition, you can increase the mortgage amount and pocket the cash.
Advice: Keep that excess mortgage amount below $100,000. That's because the excess amount is treated as home-equity debt for income tax purposes. As long as the excess amount (plus existing home-equity loans) does not exceed $100,000, you can fully deduct the interest as long as you're not subject to the alternative minimum tax.
2. Improve deductions by making home improvements
With rates rising, you may pay one or more "points" to lock in a low rate. Points paid on a refinancing are typically deducted over the life of the loan.
Advice: Combine the refinancing with planned home improvements. You can deduct any points attributable to home improvements.
For example, if you pay $2,000 in points on a $100,000 loan and you use $50,000 of the proceeds to build a swimming pool, you can write off $1,000 of the points this year.
3. Salvage write-off for points
This may be the second—or even third or fourth—time you've refinanced the original debt on your principal home.
Advice: Don't forget to write off points remaining from your prior refinancings. Although points paid on your latest refinancing aren't deductible in this current year, you can immediately deduct the balance of any remaining points from previous refinancing.
For example, if you refinanced a 30-year loan two years ago and paid $3,000 in points, you can deduct $2,800 this year if you refinance again ($3,000 original balance minus $100 deducted in each of the two years it was outstanding).