Mortgage refinancing costs consist of fees paid to third parties, like those for appraisals and title insurance, lender fees like your origination charge, and discount points, which are paid to reduce your interest rate. How these charges are treated at tax time depend on a number of factors.
First, you get a much better deal at tax time when you are purchasing your home than you do when you are refinancing it.
If you are getting the mortgage to buy your home, you can deduct the points in full in the year they are paid as long as ALL the following requirements are met:
- The property being purchased is your primary residence and you live there most of the time.
- Points are normal loan fees in your area. For example, in many locations, the origination fee for a mortgage is equal to one point.
- The points paid were not more than the amount generally charged in that area.
- The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, or property taxes.
- The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. So you could not have accepted a higher mortgage rate in exchange for the lender paying the points for you, and you could not have had the points wrapped into your mortgage amount.
- You use your loan to buy or build your main home.
- The points were computed as a percentage of the principal amount of the mortgage (each point is one percent of the loan amount).
- The amount is clearly shown as points on your settlement statement.
Points that do not meet these requirements may be deductible over the life of the loan. So, if you paid two discount points to get a lower mortgage rate on your $300,000 30-year mortgage, they would be deducted at a rate of $200 per year while you have your mortgage.
Points paid for refinancing generally can only be deducted over the life of the new mortgage.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first six requirements stated previously, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. So if a $300,000 refinance was used to pay off a $200,000 home loan and finance $100,000 of home improvements, one-third of the points paid could be deducted that year, and the other two-thirds would be deducted over the life of the loan. So if you paid a point to originate the refinance, you'd be able to write off $1,100 the first year ($1,000 plus $100) and then $100 a year for each of the remaining twenty-nine.
Points you pay on loans secured by your second home can be deducted only over the life of the loan.
What happens to the un-deducted points if you refinance or pay your mortgage off early? You get to deduct any remaining points when you retire the mortgage. So, if you paid points equal to $6,000, you'd get to deduct only $200 per year. However, if you pay off the loan after only five years, you may deduct the remaining $5,000 that year.
Finally, prepayment penalties, whether calculated as a number of months' interest or as a percentage of the mortgage amount, are fully tax deductable in the year they are incurred.