Are There Tax Consequences To Refinancing My Mortgage?

In our current low interest rate environment, many people have decided to re-finance their mortgages. While this may be a great way to save some money on their monthly payments, many people worry about the tax consequences of re-financing. The good news is that for most people, there will not be any tax consequences.

In a typical refi situation, the homeowner is simply refinancing the current mortgage, only for a lower interest rate. When this is the case, there really aren’t any tax considerations and you will still be able to deduct interest paid on your mortgage.

There is a second type of refinancing, however, called “cash out” refinancing. With this type of refinancing, a new loan is taken out on a larger principal sum than what is currently owed on their home.

This essentially allows homeowners to cash in on some the equity they have built up in the home. Often, when individuals decide to do this type of refinance, they wonder if the loan proceeds will be considered income. The answer to that question is no.

Loan proceeds are not considered income by the IRS because they will need to be paid back. When this refi route is chosen, the deductibility of interest may be at risk. The main question to ask is “how will the proceeds be used?”

In order to continue deducting interest on the entire loan, the proceeds must be used for capital improvements to the home (pool, new roof, new energy efficient windows, new fence, etc). If the proceeds are used for anything else, like paying down credit card debt, or buying a new car, that portion of the mortgage interest will no longer be deductible.

Evan Fennema, Tax Advisor