The balance on the old loan was $275,000. You can deduct interest on $275,000 of the new loan, plus another $100,000 of the new loan, for a total of $375,000. The amount of interest you paid on the remaining $25,000 of loan is considered personal interest, which is not deductible. However, if $25,000 or more had been spent to improve the home, such as to add a room, then all of the interest would be deductible as housing interest.
Another example shows how much you can save from the tax deduction. If you get a mortgage loan for $50,000 at 10% interest for 30 years, your monthly payment is $438.79. Over the first year, you will pay $5265.43, of which $4987.43 is interest. By deducting this interest on your tax return, you will save $1396.48 in taxes (at a tax rate of 28%). This means that the real cost of your mortgage payments is only $322.41 per month.
Keep in mind that if you don’t itemize your deductions, you can take the standard deduction of $7,350 for a married couple in 2001. Therefore, only the amount of itemized deductions above the standard deduction actually represents tax savings. In the example above, if you had no other itemized deductions, you would be better off taking the standard deduction, and the deductibility of interest would be of no practical benefit. Note that itemized deduction amounts begin to phase out (diminish) when income exceeds around $129,000 for married taxpayers filing a joint return in 2001 (half that for singles). The exact income limit is indexed and increases each year. Consequently, for very high-income homeowners, there is no tax benefit derived from financing a home.
In some cases, you can deduct discount points paid to get a mortgage loan to buy a house, but not for refinancing. The points must be customarily charged in your area. If you write a separate check for these points, rather than let the lender deduct the amount from the loan, these points are tax deductible in the year they are paid. However, if the loan was used to refinance an existing loan rather than a new purchase, you cannot deduct discount points in one year. You must spread the cost of the points over the life of the loan. |
