How often have you been involved in a real estate transaction and decided to put down a large down payment just to “get the deal done”?  After all, you’re a good risk and expect to get a loan whenever you want it.  You’ll just refinance the loan later and “pull cash out”

It would be easy for me to shake my head and suggest that you are getting poor financial advice…that would be easy.  You might be violating the tax code if you deducted that interest from the larger loan if you took it out after 90 days from the close of escrow.   AND…you probably got away with it…up until next year.

A few things you should know about the deductibility of mortgage interest:

1- It is limited to $1.1 million.
2- You must itemize (Schedule A) to receive that deduction.
3- A fully-amortizing loan reduces your Acquisition Indebtedness each month.
4- An interest-only loan does not reduce your Acquisition Indebtedness; it remains level.
5- You are entitled to a $100,000 over the Acquisition Indebtedness as a home equity exclusion for tax deductibility.

Now, here’s the catch.  The IRS monitors your interest paid on mortgages through a Form 1098.  The IRS has no formal system to monitor the segregation of debt (how much was the Acquisition Indebtedness, how much is covered under the home equity exclusion, and how much is not deductible)…UNTIL NOW.

In 2007, lenders are required to report cash-out refinance transactions.  That includes any and all refinanced loans that exceed the original Acquisition Indebtedness.  This means that if you bought a home in 2000 with a $250,000 loan against it and have subsequently increased that debt to $400,000, your qualifying debt for interest will be capped at $350,000, more if you paid down the loan through an amortized loan.  In California, that applies to MANY refinance transactions for homes owned more than three years.

Why is the IRS doing this?  Well, follow the money.  The IRS has overlooked this common ignorance of the tax code because it really didn’t affect the average Joe…until NOW.  The real estate boom gave homeowners a chance to use their home like an ATM and withdraw cash.  Now, the IRS wants it’s pound of flesh.  If you’ve refinanced and pulled out cash over and above $100,00 above your Acquisition Indebtedness, you had better start paying attention to your deductibility of mortgage interest …because Uncle Sam is…next year.

Mortgage planning encompasses this information and works with your tax professional to ensure that you get the largest tax-deduction available.  You can always opt against that advice and put down a larger down payment.  Wouldn’t you like to make an educated choice?

Ask the mortgage salesman your Realtor recommended why she didn’t tell you about this when you bought your home; she could cost you a lot of money next year.


Special thanks to Brian Brady, for giving me permission to reprint this post. To subscribe to Brian Brady’s Blog (highly recommended), go to  Copyright 2007 Brian Brady. All rights reserved worldwide. Brian can also be contacted via email at Brian also writes articles at:  BloodHound Blog, ActiveRain and NELA Live


One thought on “Why Paying Cash & Refinancing Later Is Bad Advice

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s