Generally, interest paid on loans to acquire an existing home or to construct a new home is tax deductible. In addition, interest paid on refinanced mortgages is deductible (also subject to certain limitations).
If you refinance the current principal balance owed on a mortgage secured by your primary or secondary residence (a no-cash-out refinance), interest on the refinanced loan will be deductible to the same extent as was the interest on the old loan. If, however, the refinanced loan is for more than you owed on the old loan (a cash-out refinance), deductibility of interest on the amount of the loan that exceeds the principal balance of the old loan is determined as follows:
Here, the former amount is treated as home acquisition debt, and the latter amount is treated as home equity debt.
Example(s): Suppose you took a mortgage of $150,000 to purchase a home costing $200,000. Eight years later, when your home's fair market value is $250,000 and you owe $135,000 on the original loan, you take a cash-out refinance mortgage of $190,000 on your home. (Assume you are married, file jointly, and have no other mortgages on the home.)
All of the interest on the first $135,000 of the new loan is considered remaining home acquisition debt and is fully deductible (because it does not exceed the $1 million limitation).
Of the $55,000 excess ($190,000 borrowed minus $135,000 owed), you use $30,000 to add a bathroom to your home and $25,000 to pay off bills and buy a car. The $30,000 will be considered home acquisition debt, and interest on it will be fully deductible, since you're still within the $1 million limitation. The $25,000 will be considered home equity debt and will also be fully deductible, since you are within the $100,000 limitation.
If you refinanced a loan on your primary or secondary residence before October 14, 1987, it will be subject to neither the $1 million/$500,000 home acquisition debt limit nor the $100,000/$50,000 home equity debt limit, as long as the amount borrowed does not exceed the remaining principal balance on the old loan (i.e., as long as it was a no cash-out refinance).
Caution: If, however, the loan you took was a cash-out refinance, then the excess borrowed will be subject to the home acquisition and home equity debt limitations.
The Housing and Economic Recovery Act of 2008 included the HOPE for Homeowners Act of 2008 (the Act). The Act created a temporary refinance program within the FHA for homebuyers at risk of foreclosure. Lenders can write down qualified mortgages to 85 percent of the current appraised value and qualified borrowers can get a new 30-year fixed mortgage at 90 percent of the home's appraised value.
The loan limit for this program is $550,440 nationwide, and the program is effective on October 1, 2008 and expires September 30, 2011.
Be aware, however, that lenders are not required to participate in this program; they may volunteer to forgive loan balances down to 85 percent of current market value. Further, the borrower must share the newly-created equity and future appreciation equally with FHA. This obligation will continue until the borrower sells the home or refinances the FHA-insured mortgage. Moreover, the homeowner’s access to the newly-created equity will be phased-in over five years.
The equity share phase-in schedule is as follows: