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With attractive mortgage rates beckoning (see Money Update on page
35), millions of Americans are thinking about refinancing. If you're
among them and you haven't factored in the tax-related costs, you
haven't been noodling hard enough; taxes, in fact, could be the
decisive element. So before you see your banker, take the following
crash course in refinancing basics.
Your interest write-offs will depend mainly on how much you borrow
and how you spend the money. In general, you can deduct the interest
on the portion of the new loan that goes to pay off your old mortgage
balance. (If you took out your mortgage before Oct. 14, 1987,
however, you may face exceptions to this rule, particularly if the
term on the new loan extends beyond the period that remained on your
old mortgage. Check with a tax pro if this is the case.) If you
borrow more than the balance remaining on your old mortgage, you can
write off the interest on the excess by using the money for
substantial home improvements, like adding or remodeling a room. To
qualify for the deduction, you must make the home improvements within
two years of getting the loan or take out the loan within 90 days of
completing the changes. Another hurdle: all of the mortgages that you
have taken to buy, build or upgrade your principal residence and a
second home cannot exceed $1 million.
If you use the extra cash for purposes other than home
improvements, the tax law generally considers that money to be a
home-equity loan. Accordingly, you can almost always deduct the
interest as long as your total home-equity debt doesn't exceed
In any refinancing, you can deduct all the points, provided that
the loan amount falls under the $1 million or $100,000 cap. (A
point equals 1% of the loan amount; most lenders charge two to four
points.) But only the points attributable to money spent on home
improvements are deductible in the year you pay them. In most other
cases, you must spread the write-off over the life of the loan.
Always pay refinancing points with a separate check. ''You'll lose
the deduction if you let the bank subtract points from your loan,''
warns James Mulvaney, tax manager at BDO Seidman in New York City.
Then, for more and more taxpayers every year, there's the game of
trying to sidestep the alternative minimum tax -- a stiff levy
imposed on people whose write-offs reduce their tax bill below an
acceptable minimum for their income level. If you are snared by the
AMT, the interest on a refinanced mortgage that is considered
home-equity debt is not deductible. Check with an accountant before
you refinance, particularly if other factors -- like hefty state tax
write-offs -- make you susceptible to the AMT.