Janet Berry-Johnson, CPA, is a freelance writer with a background in accounting and income tax planning and preparation for individuals and small businesses. Her work has appeared in Business Insider and The New York Times. Janet has been nominated a.
Janet Berry-Johnson, CPA Taxes ExpertJanet Berry-Johnson, CPA, is a freelance writer with a background in accounting and income tax planning and preparation for individuals and small businesses. Her work has appeared in Business Insider and The New York Times. Janet has been nominated a.
Written By Janet Berry-Johnson, CPA Taxes ExpertJanet Berry-Johnson, CPA, is a freelance writer with a background in accounting and income tax planning and preparation for individuals and small businesses. Her work has appeared in Business Insider and The New York Times. Janet has been nominated a.
Janet Berry-Johnson, CPA Taxes ExpertJanet Berry-Johnson, CPA, is a freelance writer with a background in accounting and income tax planning and preparation for individuals and small businesses. Her work has appeared in Business Insider and The New York Times. Janet has been nominated a.
Taxes Expert Deborah Kearns Mortgages ExpertWith two decades of experience as a respected journalist and communications leader in the mortgage field, Deborah Kearns is passionate about helping consumers make smart homeownership and personal finance decisions. Her work has appeared in The New Y.
Deborah Kearns Mortgages ExpertWith two decades of experience as a respected journalist and communications leader in the mortgage field, Deborah Kearns is passionate about helping consumers make smart homeownership and personal finance decisions. Her work has appeared in The New Y.
Deborah Kearns Mortgages ExpertWith two decades of experience as a respected journalist and communications leader in the mortgage field, Deborah Kearns is passionate about helping consumers make smart homeownership and personal finance decisions. Her work has appeared in The New Y.
Deborah Kearns Mortgages ExpertWith two decades of experience as a respected journalist and communications leader in the mortgage field, Deborah Kearns is passionate about helping consumers make smart homeownership and personal finance decisions. Her work has appeared in The New Y.
Updated: May 26, 2023, 5:00am
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If you’re a homeowner looking to access some of your home’s equity, you may want to consider a cash-out refinance.
A cash-out refinance allows homeowners to tap their home’s equity without selling their house. But before diving into this option, you need to understand the potential tax implications of a cash-out refinance.
A cash-out refinance loan allows homeowners to access their equity by taking out a new home loan that is larger than their existing mortgage. The homeowner receives the difference in their home’s value and existing loan balance in cash, and they can use the proceeds for any purpose, including home renovations, consolidating other high-interest debts, funding a child’s education or buying another property.
The new loan replaces their existing mortgage, so a cash-out refinance can raise or lower their interest rate and extend (or shorten) the loan term.
The funds from a cash-out refinance are not considered taxable income. This is because the money received through a cash-out refinance is a loan you must repay.
However, depending on how you use the loan proceeds, a cash-out refinance loan might qualify you for a tax deduction.
If you use the money from a cash-out refinance, a home equity loan or home equity line of credit to “buy, build, or substantially improve” the property that secures the loan, the IRS allows you to deduct the mortgage interest from your annual tax bill.
As with most tax rules, there are some limitations to remember before you get your heart set on deducting the interest on a cash-out refinance.
For example, say your existing mortgage balance is $650,000 on your primary residence and you have a mortgage balance of $100,000 on your vacation home. If you take out an additional $100,000 in a cash-out refinance, none of it would be deductible—you’re already at the $750,000 cap between your two properties.
What happens if you use the funds from a cash-out refinance for other purposes, such as paying off high-interest credit card debt or covering higher education expenses? In those instances, the interest paid on the cash-out portion of your new loan isn’t deductible, but the existing mortgage balance is.
Let’s say your current mortgage balance is $400,000. You do a cash-out refinance for $450,000 and use the extra $50,000 to pay for your child’s wedding. Because you didn’t use the proceeds for home improvements, you cannot deduct the interest paid on that $50,000, but you can continue to deduct the interest on the existing $400,000 balance.
If you do a cash-out refinance and file for the mortgage interest deduction, keep detailed documentation on how you used the money in case the IRS questions it.
Your mortgage lender might allow you to “buy down” your interest rate by paying points. If the interest on your cash-out refinance is deductible, then the points are also deductible. However, they also count toward the $750,000 limit.
A cash-out refinance can be a great option for accessing some of the equity in your home when used in the right circumstances. This usually means you can qualify for a lower interest rate and are planning to put the money to good use.
For example, it might be a good choice if you’re using the cash to increase the value of your home by remodeling your kitchen or bathroom, replacing old energy-inefficient windows or adding a deck. These improvements can increase the enjoyment of your home now and potentially add value that you’ll recoup when you sell.
If you can take advantage of the tax deduction, that’s just icing on the cake.
Despite the upsides, a cash-out refinance is not the best option in all circumstances. One of the main risks is losing your home if you borrow more than you can afford to repay or run into financial hardship down the road.
Like other mortgage types, a cash-out refinance loan is secured by your home. So if you stop making payments, the lender can foreclose on the property.
For that reason, avoid using a cash-out refinance for non-essential spending, such as buying a new car or paying for a vacation. And if you don’t need the money and just want to take advantage of a lower interest rate or lower your monthly payment, you’re better off with a simple rate-and-term refinance without tapping your home equity.
If you’re still unsure how a cash-out refinance could impact your taxes, consult with a qualified tax professional for more personalized advice.
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