top

With interest rates at more than a 40-year low, many taxpayers are currently refinancing real estate mortgages, some even for a second time. In many cases, refinancing will involve a loan origination fee or similar charge, generally described as “points.” The IRS recently issued a release reminding taxpayers of the tax treatment associated with points, both with acquisition loans and refinancings.

top

Points incurred on loans for the purchase or improvement of a residence are immediately deductible. The home must be the taxpayer’s principal residence (not a seasonal home) and the borrower must actually pay the points, as opposed to financing their cost.

The IRS announcement pointed out that points are charges or fees measured by the amount of the loan, such as 1% or 2% of the borrowed amount. They will often be described on the closing statement as loan origination fees, or may be identified as processing fees, loan charges, or premium fees. On the other hand, other charges incurred in a financing transaction, such as appraisal fees, recording fees, legal costs, and the like are not deductible.

top

Points incurred in a home refinancing are also deductible, but must be amortized over the term of the loan. The term of the note relates to its legal duration, and not necessarily the amortization period. For example, a taxpayer may refinance, locking in a new rate for five years, at which point the loan comes due and must be refinanced. Even if the monthly payments are calculated on a 15-year amortization, the points in this case would be amortized over the five-year actual duration of the debt

If a refinancing involves additional borrowing for home improvements, a portion of the refinancing points will be deductible.

Example: Lea has a $100,000 existing mortgage. She refinances in the amount of $150,000, using the extra $50,000 of proceeds to do landscaping and some interior remodeling. If Lea incurs a 1% or $1,500 loan origination fee, she may immediately deduct $500, but must amortize the other $1,000 over the term of the new mortgage.

Beyond tax implications, a fundamental aspect of any refinancing decision is the payback period. For example, if the refinancing requires $3,000 of points and other charges and results in a decrease in the monthly mortgage payment of $100, there is a 30-month payback period (before considering lost interest on the $3,000 outlay). If the homeowner anticipates selling before the end of that payback period, such as due to a job relocation, refinancing could be inefficient.

In most cases, today’s low interest rates, combined with the ability to lock those rates into a mortgage for a significant period of time, represent a tremendous opportunity. Let us know if you have any questions about the economics or tax treatment of a refinancing.