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Refinancing 101: Are Refinance Costs Tax Deductible?

by | Jun 23, 2020

Who couldn’t use some extra cash?  Refinancing your home is one of several smart ways to save money. You could end up with a lower monthly payment or pay less for your home in the long run. You may even be able to deduct some of your refinance expenses. 

At first glance, though, refinancing looks like it may cost you money. With all of its closing costs, are you saving money?   That leads to the question, are refinance costs tax-deductible?   In short, yes, some refinance costs are tax-deductible, but not all of them. Keep reading to learn about what fees you can deduct and which ones you cannot. 

What refinance costs are tax deductible?

The following refinance costs are tax-deductible on a residential refinance: 

  • Mortgage interest
  • Real estate taxes
  • Closing costs

Mortgage interest includes mortgage insurance premiums for contracts that were issued from 2014 to 2019. If you paid those premiums in the tax year, you can still deduct the premiums. 

Are mortgage points tax deductible?

Mortgage points or discount points are the money you pay in advance to reduce your interest rate. So if you have allocated points over the life of a loan, you can deduct those as well. 

The IRS considers discount points to be prepaid interest. Thus they are tax-deductible.  One point will cut down 1 percent of your loan amount. So when you pay 3 points on a $100,000 loan, you’ll have paid $3,000. Mortgage points are also called discount points, a loan discount, a loan origination fee, and a maximum loan charge. 

If you want to pay your points as a part of a mortgage refinance, you have to deduct those points over the life of a loan. So when you refinance a 15-year mortgage, you divide those points down by 15, and that is what you can deduct. 

Refinance points thus look different than points on an original mortgage. With the original mortgage, you paid points upfront when you bought the home. 

Read on to learn more about this important refinance program offered by Freddie Mac that will help you with lower mortgage payments and the chance to build equity in your home.

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Are refinance costs not tax deductible?

Typically, settlement fees are not tax-deductible. These fees would include costs such as the following: 

  • Fees for title insurance
  • Fees for appraisals
  • Fees for attorneys
  • Fees for inspections
  • Legal and recording fees

Note, also, that you may not deduct mortgage insurance premiums when you have an AGI (adjusted gross income) of more than $109,000 or $54,500 if you’re married but filing separately.

What are typical closing costs on a refinance?

A refinance will cost you some necessary closing costs and fees. It would help if you prepared yourself for these costs as you look to refinance your home. Also, knowing what each cost is will help you determine if the costs are tax-deductible or not. 

These are typical closing costs: 

  • Early repayment fees: Some lenders will fine you for paying your loan off early. This usually happens if you attempt to pay off your mortgage within the first three to five years of its existence. FHS and VA loans cannot include this penalty because a federal agency backs them. 
  • Discount points: These are interest payments based on the amount of your mortgage. You can prepay these points to make your long-term interest rate lower. Paying points makes sense if you plan on staying in your home for a long time. 
  • Origination fees: Lenders spend a lot of time putting together the paperwork required for your refinance so that they will charge you an origination fee for their work. They need to process your loan and procure a credit report. Lenders will also call these fees administration, application, underwriting, or document preparation fees. 
  • Appraisal and inspection fees: Appraisal fees will cost around $300- $400. You can sometimes waive the appraisal fee if you bought your home recently and it was appraised then. Sometimes the lender will require a termite and pest inspection as well. 
  • Mortgage and title insurance fees: The mortgage insurance fee is the insurance a lender requires if you have a government-backed loan from FHA or the Department of Veterans Affairs. If you have a regular mortgage where you put less than 20 percent down, you will have to pay for private mortgage insurance. The lender will also require title insurance, which covers the cost of any errors in the title. 

Small fees will add up. Each one of these is essential, though, for a successful refinance. 

How much should I pay in closing costs for a home refinance?

With all of these different fees, you may wonder, how much are closing costs on a refinance?   Your costs for refinancing depend on your outstanding principal on your current mortgage. You can expect to pay 2% to 5% of your outstanding principal for your closing costs. 

So if you have a current outstanding principal of $100,000, you can expect to pay from $2,000 to $5,000 in closing costs to refinance your home. 

Are rental properties tax deductible?

All of the above tax deduction rules apply only when you are refinancing your residence. However, if you’re refinancing rental property, the rules change.  A rental property is a way that you generate income, so it’s your business. Thus the IRS treats a refinance for a rental property differently than one for a residential property.

When you receive rent from a tenant, you must report that rent as income. Conversely, you can deduct the money you spend to generate income from your rental income. So when you improve the rental home such as refinancing it, you can deduct the refinance costs. 

Not only can you deduct interest and points paid, but you can deduct all closing costs and fees on rental property. 

Itemize and save

You can now confidently answer the question, “How much are closing costs for a refinance?” More importantly, you understand that what you spend is something you may be able to deduct. 

When you keep track of your refinance costs, you can itemize them and deduct them on your next tax return.

If you’re looking to learn about ways to save, check out our blog!

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