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Q: I currently have a $26,000 mortgage. A few years ago, I also took out a $40,000 home-equity loan to pay for a few home improvements and consolidate bills. Now, I want to refinance and combine these two loans into a single mortgage. I also want to take out some equity to make a few more home improvements. How do I determine what interest payments will be deductible from my income taxes? Someone told me I might not be able to deduct all interest payments related to a refinancing.
- E.L., Dover, N.H.
A: It's true that mortgage-interest deductions aren't unlimited, but I think you're going to be alright.
The key rules that apply:
** Acquisition debt. You're generally allowed to deduct interest payments on your "acquisition debt," which the Internal Revenue Service defines as a mortgage incurred to buy or substantially improve your home.
Your acquisition debt is the mortgage you obtained to buy the home, minus any principal payments you've made.
However, you can only deduct interest on up to $1 million of this debt ($500,000 for single taxpayers). That means that if you have an extremely expensive home, the IRS might not let you deduct all interest payments.
** Home-equity debt. You can usually deduct all interest on all or part of a home-equity loan that's used to finance housing repairs or improvements.
If you're using the loan for debt consolidation or something else other than home improvements, you can deduct interest on up to $100,000 above your acquisition-debt limit.
** Other rules. One additional limit may come into play for borrowers who refinance. The total tax deductible mortgage debt on a home can't exceed the home's current value.
How do these rules apply to you?
Well, your current acquisition-debt limit is $128,000. That's your existing mortgage ($28,000) plus a maximum of $100,000 on an equity loan.
Rolling your $26,000 primary mortgage and $40,000 home-equity loan into a single $66,000 mortgage would leave you well under that acquisition-debt ceiling.
In fact, you could borrow another $62,000 and still deduct all interest, as your total borrowings would still equal your $128,000 acquisition-debt cap.
This assumes, of course, that the loans don't exceed your home's value.
Although some lenders DO approve loans in excess of a home's value, the IRS won't let you deduct interest on the excess unless you're using those funds to finance home improvements.
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