Watch for tax deduction pitfalls

Pencil on income tax form

If you have refinanced your house in the last year, in addition to mortgage interest, you may be allowed to deduct some of the fees you paid for your new loan.

In most cases, the Internal Revenue Service allows homeowners to deduct the points they pay on their new loans. But there are a few differences in what you can deduct as a result of refinancing your mortgage versus when you took out the original loan on your home.

If you itemize your tax return, then the points you paid to receive a new mortgage are deductible as mortgage interest. Unlike when you first buy a home and the points are deducted from that current year’s income taxes, points paid during a home refinance have to be amortized, or drawn out, over the life of the loan.

So, if you refinance your $200,000 home and paid two points (2%), then your tax deduction will be $4,000 spread out over the length of your loan. This is quite a difference from the tax benefit new homeowners enjoy. $4,000 over a 30-year mortgage will only reduce your taxable income each year by $133.

There are a few exceptions: If you used money from the refinance to make repairs or improvements to your house, you may be able to deduct any points you pay in the current calendar year if you meet certain criteria set out by the IRS. Also, if you decide to refinance your home again or sell your home before paying off your mortgage, the outstanding interest can be written off that year’s taxes.

Paying points on your new mortgage can be a great way to save a ton of money in interest payments over the course of your loan.

Our mortgage calculator shows a homeowner can expect to save more than $47,000 in interest off a $200,000, 30-year fixed mortgage by reducing the annual interest rate by just 1% after paying a point. This is a cost savings that should not be ignored.

For more information on the home mortgage interest deduction, visit the IRS’s website.

Follow on Twitter.