UtilibyThe short answer
In the United States, the interest you pay on a mortgage to buy, build or substantially improve your main home or a second home can be tax deductible, but only if you itemize deductions instead of taking the standard deduction, and only up to a limit on the loan size. A refinance does not change this basic rule. What it changes is how much interest you pay, how points are treated and whether cash-out money counts. The details below apply to the US, and tax law changes, so check the current IRS publications or a tax professional for your own case.
Why itemizing matters most
Mortgage interest is an itemized deduction. Each year you choose the larger of two amounts: the standard deduction, or the total of your itemized deductions, which include mortgage interest, state and local taxes up to a cap, and charitable gifts, among others. Many homeowners find the standard deduction is larger, in which case the interest brings no extra tax benefit at all, and a refinance that lowers the interest does not raise your tax bill either.
This is why the after-tax effect of a refinance varies so much. If you itemize and are in a higher bracket, a lower rate also lowers your deduction, which cuts the benefit of the saving. If you take the standard deduction, the full payment saving is yours. Ask a tax professional, or look at last year's return, to see which side you are on.
Is refinance interest deductible?
Generally yes, within limits. Interest on a refinanced loan is treated like interest on the original loan, as long as the loan is secured by your home and is used for qualifying purposes. Under current federal rules, interest is deductible on up to a set amount of home acquisition debt. The limit has been 750,000 for most recent loans, and 375,000 if married filing separately, while older loans may have a higher limit. When you refinance, the limit applies to the amount of the old loan that remains, plus any amount used to improve the home.
That last point matters. If you refinance 300,000 of old acquisition debt into a new loan of 300,000, the whole amount keeps its status. If you borrow more, the extra amount is treated according to what you do with the money, as the next section explains.
Cash-out refinancing and the use of the money
When you take cash out, the interest on the extra borrowing is deductible as home mortgage interest only if you use the money to buy, build or substantially improve the home that secures the loan. If you spend it on something else, such as paying off credit cards, buying a car or paying tuition, that part of the interest is not deductible as mortgage interest, though other rules could apply. Keep records of how you spend the money, and consider keeping the cash-out funds separate.
The Cash-Out Refinance Calculator shows how much cash you can take and what it costs. The tax question is separate, and the answer depends on what you do with the money.
Points and closing costs
Closing costs on a refinance, such as the appraisal, title fees and recording charges, are generally not deductible. Discount points are treated differently. Points paid on a refinance are normally deducted over the life of the new loan, not all at once. So 3,000 of points on a 30-year loan gives about 100 of deduction each year, if you itemize. There is an exception for part of the points that relate to money used to improve the home, and a special rule if you later pay off the loan early, when the remaining balance of points may become deductible.
The Closing Costs Calculator separates the points from the other fees, which makes it easier to see what might be deductible and what is not.
Worked example: the after-tax effect
If the homeowner takes the standard deduction, the interest makes no difference to the tax bill, so the after-tax saving is the full 2,880. If the homeowner itemizes in the 24% bracket, the 3,000 of lower interest cuts the deduction and raises the tax bill by about 720. The after-tax saving is then about 2,160 in the first year. The refinance still pays, but by less. The Break-Even Calculator shows the pre-tax figure, so adjust for your own situation.
Mortgage insurance and other costs
The deduction for mortgage insurance premiums has been available in some years and not in others. If you pay private mortgage insurance, check the current IRS rules for the year in question. Property taxes are a separate itemized deduction, subject to the cap on state and local taxes. The Remove PMI Refinance Calculator shows the cost of the insurance, which you can compare with any tax benefit.
Investment property and home offices
If the refinanced property is a rental, the rules differ. Interest on a loan for a rental property is generally deducted against rental income, not as an itemized home deduction, and the costs of the refinance are often spread over the life of the loan. Part of the loan may be treated differently if you use part of the home for business. These cases are worth a conversation with a tax professional. For a rental, the Rental Property Refinance Calculator covers the cash-flow side.
Quick reference: what is usually deductible
| Item | Usually deductible? | Notes |
|---|---|---|
| Interest on the refinanced balance | Yes, if you itemize | Within the federal debt limit |
| Interest on cash-out used to improve the home | Yes, if you itemize | Keep receipts and records |
| Interest on cash-out used for other purposes | Generally no | Other rules could apply |
| Discount points on a refinance | Over the life of the loan | Special rules if you pay off early or use money to improve the home |
| Appraisal, title, recording and similar fees | Generally no | May affect your cost basis in some cases |
| Prepaid interest at closing | Yes, as interest, if you itemize | Shown on the Closing Disclosure |
| Property taxes paid through escrow | Yes, if you itemize | Subject to the cap on state and local taxes |
The table is a guide, not a ruling. Your own situation, such as the use of the home, other debts and your state, can change the answer.
How to estimate your own after-tax saving
- Find the monthly payment saving with the free Mortgage Refinance Calculator.
- Estimate the change in first-year interest. The calculator's amortization table shows the interest in each year for the old and new loans.
- Check whether you itemize. If you take the standard deduction, stop here: the pre-tax saving is your saving.
- If you itemize, multiply the drop in interest by your marginal tax rate. That is the tax benefit you lose.
- Subtract it from the yearly payment saving to get the after-tax saving.
- Add the points, if any, spread over the loan. A small yearly deduction, but it offsets a little of the cost.
Remember that the first year is the highest interest year. Over time the interest on both loans falls, so the tax effect shrinks and the pre-tax saving is a better guide to later years.
Records to keep
Keep the Closing Disclosure from your refinance. It shows the points, the prepaid interest and the fees, and it is the document a tax professional will ask for. After the year ends, your lender sends Form 1098 showing the interest you paid, and often the points. Keep the settlement statement from your original purchase as well, because it can matter for the basis of the home. If you take cash out for home improvements, keep contractor invoices and receipts. If you are audited, these records are how you show that the money went into the home.
If you refinance more than once, the points from the earlier refinance that you were spreading over the old loan may become deductible in full when you pay off that loan, unless you refinance with the same lender, in which case special rules can apply. Ask a tax professional how to treat them, and keep notes on the dates and amounts.
What to do before you refinance
- Look at last year's return and see whether you itemized.
- Estimate the change in your interest and the effect on your tax, using your marginal rate.
- Decide how you will use any cash out, and keep records.
- Keep your Closing Disclosure, which shows the points and interest, and ask your lender for Form 1098 after the year ends.
- Ask a tax professional about anything unusual, such as a rental, a business use or a large loan.
Related guides and tools
More from Utiliby on refinancing:
- How to Calculate Mortgage Refinance Savings: the maths behind the savings.
- Mortgage Refinance by State: Costs and Taxes: state taxes and costs.
- Refinancing with Bad Credit, Self-Employed Income or Negative Equity: when a refinance is harder to get.
Free tools:
- Refinance vs HELOC Calculator: compare ways to borrow against your home.
- Refinance Break-Even Calculator: the payback month.
Sources
- Internal Revenue Service, Publication 936, Home Mortgage Interest Deduction (irs.gov/publications/p936).
- Internal Revenue Service, Topic No. 505, Interest Expense (irs.gov/taxtopics/tc505).
- Internal Revenue Service, Topic No. 501, Should I Itemize? (irs.gov/taxtopics/tc501).
- Consumer Financial Protection Bureau, "What are discount points and lender credits?" (consumerfinance.gov/ask-cfpb).
Frequently asked questions
Is mortgage refinance interest tax deductible?
Generally yes, if you itemize and the loan is secured by your main or second home and used to buy, build or improve it, up to the federal limit. If you take the standard deduction, the interest gives no extra benefit.
Are refinance closing costs tax deductible?
Most are not. Fees such as the appraisal, title insurance and recording charges are generally not deductible. Points are treated separately.
Are points on a refinance deductible?
Points paid on a refinance are normally deducted over the life of the new loan, not in one year. A different rule can apply to points on money used to improve the home, and any remaining points may be deductible if you pay off the loan early.
Is cash-out refinance interest deductible?
Only if you use the cash to buy, build or substantially improve the home that secures the loan. Interest on the part used for other purposes is generally not deductible as mortgage interest.
What is the limit on deductible mortgage debt?
Under current federal rules, the limit is generally 750,000 of home acquisition debt (375,000 if married filing separately), with a higher limit for some older loans. Check the current IRS publication for your case.
Do I need to itemize to deduct mortgage interest?
Yes. If you take the standard deduction, you cannot also deduct mortgage interest.
Will a lower rate reduce my tax benefit?
If you itemize, yes, because you pay less interest to deduct. The refinance usually still saves money, but the after-tax saving is smaller than the pre-tax saving.
Can I deduct private mortgage insurance?
The deduction for mortgage insurance premiums has changed over the years. Check the IRS rules for the tax year in question or ask a tax professional.
What about state taxes?
State rules differ, and some states have their own treatment of interest and points. This guide covers US federal rules only.
Is this tax advice?
No. It is general information. Tax rules change, and your situation may differ, so consult a qualified tax professional or the IRS publications before you decide.