Key Terms To Know
A few terms come up again and again with this deduction.
| Term | What it means |
|---|---|
| Itemize | Listing your actual deductions instead of taking the standard deduction |
| Schedule A | The Form 1040 attachment where you list itemized deductions |
| Form 1098 | The statement your lender sends showing the mortgage interest and points you paid (and, if you bought a home that year, certain points) |
| Home acquisition debt | A mortgage used to buy, build or substantially improve your home |
| Points | Upfront fees paid to a lender, usually for a lower rate, treated as prepaid interest |
If your itemized deductions don’t exceed your standard deduction amount, the mortgage interest deduction won’t lower your tax bill.
How Much Refinanced Interest You Can Deduct
Your new loan counts as home acquisition debt only up to the principal you owed on the old loan just before refinancing. That rule comes from IRS Publication 936.
The overall caps stay the same after a refinance:
- You can deduct interest on up to $750,000 of home acquisition debt ($375,000 if married filing separately).
- Debt taken on or before December 15, 2017, keeps the higher $1 million limit ($500,000 if married filing separately). Keep in mind that refinancing older debt generally keeps the old date, up to the old balance.
What Happens With a Cash-Out Refinance
Any amount you borrow above your old balance is treated differently. If you don’t use it to buy, build or substantially improve your home, it isn’t home acquisition debt. Its interest isn’t deductible as home mortgage interest.
Here’s an illustration. Say you owe $200,000 and refinance into a $250,000 loan, using the extra $50,000 to pay off credit cards. Interest on the $200,000 qualifies, while interest on the $50,000 doesn’t. If you’d spent that $50,000 remodeling your home instead, it could count as home acquisition debt.
How Points Work on a Refinance
Points paid to refinance are generally deducted ratably (in equal portions) over the loan’s term, per IRS Topic no. 504. That holds even when the loan is on your main home.
Spreading Points Over the Loan
For example, $3,000 in points on a 30-year loan works out to $100 a year. A 15-year loan has 180 monthly payments, so you’d divide the points by 180 to get your monthly share.
The Home Improvement Exception
If you use part of the loan to substantially improve your main home and meet the IRS tests, you can deduct the points tied to that improvement in the year you pay them. You must pay those points with your own funds. You deduct the rest over the loan’s life.
Leftover Points From Your Old Loan
You may still have undeducted points from your old mortgage. When that loan ends through a refinance, you can usually deduct the remaining balance that year. If you refinance with the same lender, you spread the remaining balance over the new loan’s term instead.
Reporting Refinanced Interest on Your Return
In a refinance year, you may receive a Form 1098 from each lender. Here’s how to report the totals:
- Gather the Form 1098 from your old lender and your new lender.
- Add the interest and points shown on both forms.
- Enter that total on Schedule A, line 8a.
- Calculate the yearly share of your refinance points yourself, and enter that amount on line 8c.
Because this is a deduction, it reduces your taxable income. Tax credits work differently, since they cut your tax bill directly.
