The Benefits of Refinancing

Assuming your home was worth at least $300,000 when you refinanced, you have, in effect, two new mortgages as far as the Internal Revenue Service is concerned. The first $200,000 of your new loan (the balance on your old mortgage when you paid it off) is treated as "home-acquisition debt." And as you probably know, this interest qualifies as an itemized deduction on line 10 of your Schedule A. (Don't forget, however, that if your adjusted gross income in 2007 was greater than $156,400, or $78,200 if married but filing separately, this deduction is subject to the phase-out rules for itemized deductions.)

The remaining $100,000 of your new loan is treated as home-equity debt. The interest on this should also qualify as an itemized deduction on line 10 of your Schedule A. But keep one thing in mind: The IRS only recognizes home-equity loans up to $100,000; you can't deduct the interest paid on principal above that figure.

Also, if the home-acquisition debt plus the home-equity debt exceeded the fair-market value of your home, you generally can't deduct the interest on the excess debt. For example, say your home was worth $240,000 when you took out that new $300,000 loan. You can deduct the interest on the $200,000 of acquisition debt, but you can deduct the interest on just $40,000 of the home-equity debt. So you can deduct 80% ($240,000/$300,000) of the total mortgage interest on line 10 of your Schedule A. (The interest on the remaining $60,000 of debt is generally considered a nondeductible personal expense, though there are a couple of exceptions, like if you used the loan proceeds to finance your small business.)

What about the points related to the home-equity debt ($1,500 in our example)? You can amortize those in the same proportion as the interest, provided that the home-equity debt is $100,000 or less, and the home's value isn't exceeded by the home-equity debt plus the acquisition debt. Claim the amortization write-off for your home-mortgage points on line 10 or 12 of Schedule A.

This brings us to our last potential deduction. If you had previously refinanced your mortgage and paid points, you probably have a good-sized unamortized (or not-yet-deducted) balance for those points. You can generally deduct that entire unamortized amount when you refinance again. For example, say the mortgage you refinanced last year was taken out in a previous refinancing deal done six years earlier, back in 2001. At that time you paid $2,000 in points for your 30-year loan. You should have $1,600 worth of unamortized points left over from the 2001 loan (80% of the original $2,000 amount). On your 2007 return, don't forget to deduct the $1,600 of unamortized points. Claim your write-off on line 12 of Schedule A.