Refinancing a home is a common tactic used by homeowners to generate cash, but it can also lead you to further financial issues. Besides giving you access to your equity, it could also impact your income taxes. Whether it will affect your tax situation depends on how long you had your original mortgage and your ability to itemize deductions.
Mortgage Interest Deduction
The most direct way that a refinance could affect you is through your mortgage interest deduction. When you have a mortgage, you can deduct the full amount of interest that you pay on your taxes. Many people shop around for the best interest rate when they want to refinance. However, depending on your situation, it might make more sense to take a higher interest rate so that you can get a bigger tax deduction. You have to look at your tax return and determine if a bigger tax deduction would get you into a lower tax bracket or if it would not change your tax status.
When you file your taxes, you have the option of choosing to itemize your tax deductions or to take a standard deduction. The standard deduction is a flat dollar amount that you can deduct, depending on your tax status. If you do not have enough deductions that you could itemize to surpass the standard deduction, it does not make sense to itemize. To get a mortgage interest deduction, you have to be able to itemize your deductions. If you do not have any other deductions, the refinance will not change your taxes, even if you opt for a higher rate.
Length of Time
The amount of time that you had your original mortgage before you refinanced it will also have an impact on your tax situation. If you have a fixed rate mortgage, you pay much more interest at the beginning of the term than you do at the end. If you had only been in your house three or four years before you refinance, the change in deductions will not be noticeable. You were already paying a large amount of interest and when you refinance, you still pay a lot of interest. If you had already paid on your mortgage for 25 years and then refinance, you would have a much bigger deduction from mortgage interest.
Points and Cash Out
Besides the mortgage interest that you pay, you can also deduct any points that you pay in the first year of your new mortgage. Points are a form of prepaid interest, which means that you can deduct them the same as you would with regular interest. If you use a refinance as an opportunity to take cash out of your equity, the money you get should not affect your taxes. Borrowed money does not count as income and you can use it as you see fit.