Refinanced Your Home – Claim a Tax Deduction For Points

The mortgage refinance market has cooled off dramatically with recent rate increases. Many people, however, refinanced during 2005 and can claim tax deductions.
Refinanced Your Home – Claim a Tax Deduction For Points
Mortgage rates have been shockingly low over the last few years. This is hardly news to anyone that owns a home. The nominal rates, however, did result in a major boom for the mortgage industry. As rates jostled up and down, millions refinanced to save just the fraction more on their home loans.  Heck, many people refinanced multiple times! Alas, this rapid refinance craze has come to an end with the rise in mortgage interest rates.
If you refinanced this past year to get lower rates, I have some good news. Not only did you get lower rates, but you probably built up some additional tax deductions you can use to cut your tax bill.
To obtain a mortgage, whether new or a refinance, homeowners often have to pay points. These nasty little charges represent a percentage of the loan and are typically an upfront charge. Fortunately, points are deductible. Generally, you will claim a deduction for points as part of the mortgage interest deduction that makes our real estate industry so attractive. The type of loan, however, impacts how the points are deducted.
If you obtained a new home loan for a residence, you can deduct the full amount of the points. To do so, however, you must itemize on your tax return. Since you should be deducting the interest paid on the mortgage as well, this is a no brainer.
If you refinanced an existing home loan for a residence, however, things are a bit different. Yes, you can deduct the points paid on the refinance. Unfortunately, you have to deduct them over the life of the loan. In practical terms, you cannot deduct the full $3,000 you paid in points when you refinanced in August of last year. Instead, you can deduct a percentage of the $3,000. The percentage is the value of the points divided by the number of months of the loan. There are two ways around this tax handicap.
If you refinanced twice in 2005, and some of you did, you can deduct the full amount of the points on the first refinance. Why? You can do this because the life of the first refinance was less than a year, which all occurred in 2005.
In certain cases, points may also be immediately deductible if you used a refinance for home improvements. It is a bit technical and beyond the scope of this article. If you actually used a refinance to improve the home, and you can prove it with receipts, speak with a tax professional to write off all your points immediately.

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What counts as mortgage interest and how do I calculate it?

When an individual takes out a loan from a financial institution or establishment in order to fully or help fund the purchase of land or a residential building for the purpose of primary or secondary residency, this is known as a mortgage.  This essentially boils down to the mortgage being money that a person owes when it comes to purchasing land or a building for residential purposes. 

When individuals borrow money, the establishment or organization that funds the loan will charge the individual interest on the amount borrowed.  Mortgage interest is any amount of interest paid on of the loans identified as mortgage for an individual to buy their home, a second mortgage for an alternate residency, a line of credit or a home equity loan.  The money that the individuals need to repay for borrowing the loan, not including the loan amount, is the mortgage interest.

Calculating this amount can be a little tricky since there are different factors to consider for each individual loan.  The first number that needs to be clearly defined is the overall amount of the loan.  This is often the largest initial number for the formula.  House loans can range from just a few thousand dollars to millions of dollars, and the amount is dependent upon the home or land being purchased.  Next, individuals need their interest percentage.  This can be a percentage or two, or less in some cases, or more than eight.  Again, this will vary from individual to individual based on the standards and regulations as defined by the specific financial establishments. 

For example, a person may get a $315,000 loan for their home.  The bank may charge them a total of 6.5 percent interest.  This number is calculated by multiplying the amount of the loan ($315,000) by the percentage turned into a decimal (.065).  This amount is calculated to be $20,475.00.  $20,475 is the amount of interest due for a single year.  In order to calculate the overall amount of interest that the individual has already paid, they need to take their annual interest rate and multiply it by the number of years that they have been paying their mortgage.  Individuals who are looking for the amount of interest that they will pay overall can multiply the annual interest by the total number of years that the individual has to pay off the mortgage.  This number is specified in the loan and varies from loan to loan and financial establishment to financial institution.

A simple equation follows:

Loan Amount (L) x the Interest (I) = Annual Loan Amount (A) x Years (Y) = Total Interest (TI)

L x I = A
A x Y = TI

The interest percentage needs to be turned into a decimal.  This is done by placing a decimal point two places to the left of the interest rate.  For example, 6.5% becomes .065, 8.9% becomes .089, 3.2% becomes .032 and so on.

Typically, the higher a person's mortgage payment is per month, the lower their interest will be when compared to an individual who has a lower monthly payment and the same loan and loan repayment period of time.  This is because individuals who pay their loans off faster have borrowed the money for less time.  Therefore, they are able to pay the establishment back faster.  The less time a person borrows money, the less interest they will be required to pay since interest is paid back over time.

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Tax Reform – Limit of Mortgage Tax Deduction

A committee appointed by President Bush has come up with an alarming recommendation. They want to limit the tax deduction for mortgage interest!

Reform

Following his re-election, President Bush set up an aggressive agenda in which he hoped to reform social security and the tax code amongst other things. As with many things in the political world, this sounded easier done than it really was. With social security, political forces have forced the President to pull back from private accounts. With tax reform, a similar political and practical mistake is being made.

Limited Deduction

The bipartisan tax reform committee appointed by President Bush is making a mess of things. They are proposing the elimination of the Alternative Minimum Tax, which is clearly a good thing. Unfortunately, they are also proposing a limit on the tax deduction you can take for mortgage interests.

Although the final recommendations are not yet published, leaks have led to the belief the tax reform committee is going to propose the mortgage interest tax deduction be limited to the percentage of any loan that the Federal Housing Administration would write. Put another way, you would only be able to write-off interest on the first $315,000 of a mortgage! On top of this disaster, the committee is proposing to eliminate the deduction for property taxes.

Economic Disaster?

The implementation of the above recommendations would be an economic disaster for the United States. The real estate industry would suffer incredibly and the real estate boom would become a bust.  In many parts of the country, a single family home averages well over $315,000. In San Diego, the average cost of a home is in the $600,000 range. To get into such homes, many families apply for interest only loans to make ends meet. If they lose half of the interest deduction, default will not be far behind.

Once again, we are faced with a situation where politicians just don’t get it. Our housing market is incredibly strong and they want to throw a wrench in the process. Developers and homeowner associations have vowed to fight this “tax reform”. You should as well if losing half of your deduction troubles you.

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