New refinance may not bring a greater mortgage interest deduction

The number of homeowners refinancing their home mortgages continues to climb, comprising nearly two-thirds of all home-loan applicants.

Mortgage interest rates have remained lower than expected as investors have rushed to purchase the security of United States Treasury bonds in light of the disaster in Japan and unrest in other areas of the globe.

Economists from the Mortgage Bankers Association first forecasted that 30-year, fixed-rate mortgage interest rates would reach 5.5 percent in the second quarter this year but recently revised their predictions. They wrote that long-term rates would remain at 5 percent in the second quarter, then rise to 5.3 percent in the third quarter and 5.5 percent in the fourth quarter.

Some loan representatives say the recent activity has been led by a group of owners seeking to grab the lowest rates they can before the predicted rise. Those homeowners, however, may not be able to deduct all of their new mortgage interest payment from their federal income taxes.

Buyers need to be aware of the mortgage interest ceilings, especially heading into the April 18 tax deadline. According to the Internal Revenue Service, taxpayers may deduct interest on no more than a combined total of $1 million of “home acquisition debt” for a primary home and secondary residence. Home acquisition debt means any loan used to acquire, to construct, or substantially to improve a qualified home.

Taxpayers may also deduct up to a combined total of $100,000 of home equity debt on their first and second homes. Home equity debt is defined as a loan whose purpose is not to acquire, to construct, or substantially to improve a qualified home.

(The limit is reduced to $500,000 if you are married and filing separately. See Internal Revenue Service Publication 936 for details.)

Taxpayers often are confused by the amount of mortgage interest they can deduct after they refinance. If you did refinance last year, double-check your numbers. You can only deduct interest on the original amount of the loan at the time you refinance, plus $100,000.

For example, let’s say you purchased your home 10 years ago for $100,000 and took out a loan for $80,000. Since then, you have paid the loan down to $20,000. The house is now worth $275,000 and you want to buy a second home in Poulsbo. The house definitely has equity to tap, but your mortgage interest deduction would be limited to the first $120,000 ($20,000 old loan at the time of “refi”, plus $100,000).

It is important to remember that home-loan interest deductions simply reduce your taxable income. They are not dollar-for-dollar tax credits that are subtracted from your tax bill. If you have a $1,000 a month mortgage payment and are in the 15 percent tax bracket, only about $150 a month escapes being taxed in the early months of the loan.

You can deduct the loan fees (“points”) paid to buy or improve your main home in the year of purchase. You cannot deduct these fees in the year you refinanced if you refinanced only to obtain a lower interest rate on your loan.

And, talking about a purchase . . . If you’ve accepted a new job and purchased a new home, your moving expenses can be deductible depending upon the location of your new workplace. If your new job is at least 50 miles farther from your old home than your previous job (the “distance requirement”), then your moving expenses are deductible. For example, let’s assume you drove 10 miles to your old office. If your new office is 60 miles away, your moving expenses- including storage, fuel, shipping pets, cars and household goods – would be deductible.

Do your best to make the most of your taxable deductions. Don’t forget to pull out your home purchase or refinance papers. Understand there are limits to your mortgage-interest deduction and don’t underestimate moving expenses resulting from your new job.

Tom Kelly’s book “Cashing In on a Second Home in Central America: How to Buy, Rent and Profit in the World’s Bargain Zone” was written with Mitch Creekmore, senior vice president of Houston-based Stewart International and Jeff Hornberger, the National Association of Realtors’ international market development manager.