Does Refinancing Make Sense?

Mortgage interest rates are at historic lows. According to Nerd Wallet, the average rate on a 30-year loan on June 12 was 3.271%; 2.810% for a 15-year loan.

 Look into refinancing your mortgage. When you do, remember to take all the relevant factors into account – including taxes.  After you weigh the tax implications, refinancing may not be as good a deal as initially thought.

Under the Tax Cuts and Jobs Act (TCJA), if you itemize, you can generally deduct mortgage interest paid on “acquisition debt” of up to $750,000 that is used to buy, build or substantially improve a principal residence or a second home. If you have a pre-TCJA loan, the debt limit can be up to $1 million under a “grandfather rule.” If you pay points on the refinancing, they must be amortized over the length of the loan. Each point is equal to 1% of the mortgage amount.

Even if you can deduct all your mortgage interest after the refinancing, a lower interest rate will result in smaller interest expense deductions. That reduces the refinancing advantage, but you can still come out well ahead thanks to lower interest charges.

The trick is to find your “break-even point.” Online calculators can do an in-depth analysis, but here is a quick five-step method for estimating this threshold.

  • Add up all the refinancing expenses, including points, application fees, attorney fees, loan origination fees, additional insurance, appraisals, inspections, recording and survey fees, title insurance, credit reports and so on.
  • Figure out the monthly savings by subtracting your current monthly payment from the account that will be due with a refinanced loan.
  • Multiply the monthly savings by your combined federal and state income tax rate.
  • Subtract the tax cost from the monthly savings to arrive at net savings.
  • Divide the total cost by the net savings to determine the number of months it will take to pay off the refinancing. This is the break-even point, so any future savings are gravy.

For example, say you will save $500 a month by refinancing and the total cost is $10,000. As a result, it will take 20 months to recoup your refinancing costs. If you plan on moving in, say, less than two years, it’s probably not worth it. However, if you plan to stay in the home for five years or longer, refinancing likely makes sense. Other factors may affect your decision. For instance, for a mortgage without points, the rate is often slightly higher than the advertised rate.

Small Business Tax Strategies

July 2020