To better position yourself for a more secure financial future, consider refinancing your mortgage and auto loans.

Refinancing in 2021

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Melinda Nelson, CPA

It may be hard to believe, but despite the Coronavirus pandemic, record unemployment claims, and a struggling economy, things are still chugging along at a good enough clip to keep both inflation rates and interest rates at historic lows. To better position yourself for a more secure financial future, consider refinancing your mortgage and auto loans. Here are a few things to consider when shopping for a new loan.

Before you look for a new loan, get your credit into shape. Pay down as much debt as you can. Keep in mind your debt-to-income ratio is a big player in interest rates.

Get multiple quotes. Like with any big purchase, you need to shop around. Your bank may be great but there might be another lender out there who will offer you a lower rate.

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If you are trying to refinance your mortgage and you have a federal tax lien, ask your lender to subordinate the lien to the new mortgage. A subordination is when a creditor can move ahead of the government’s priority position. Many lenders will require subordination to approve a refinance as without it the federal tax lien would have priority over the new mortgage.

If you’re a business owner who applied for an Economic Injury Disaster Loan (EIDL), you didn’t qualify for a PPP loan. If you used the funds for the same purposes as a PPP loan, you could apply for a PPP loan with an option to refinance the EIDL loan into a PPP loan.

If you’re considering a cash-out refinance, be aware of the tax implications. With a cash-out refinance, you replace your current mortgage with a larger one and pocket the cash difference. The good news is the IRS doesn’t count the cash-out as income, but it does complicate your mortgage interest deduction.

You can only deduct the mortgage interest on the cash-out portion of your new mortgage if you use the funds to make capital improvements on your home. These improvements must be permanent and increase the home’s value, extend longevity, or adapt the home to new uses. You can’t deduct the interest if you used the cash-out funds for something other than capital improvements, say to pay credit card debt or buy a new boat. It may make sense to payoff high interest credit card debt with your refi but you cannot deduct the interest. The deductible interest would be based on the old mortgage balance that was refinanced instead.

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While we’re on the subject of the mortgage interest deduction, remember you can only deduct interest paid on the first $750,00 of your mortgage if married filing jointly, or $375,000 if married filing separately. In a cash-out refinance, your new mortgage also includes the cash you received and closing costs, so if the total puts you over the limitation, you may need to limit your interest deduction. You can still deduct the interest on the old mortgage balance if it qualified even if it’s above those thresholds though.

Another tax implication to refinancing is the deduction of points paid to refinance. You can deduct points on refinancing, but the deduction is spread over the years of the loan. To determine how much you can deduct, divide the total points you paid by the number of payments you’ll make over the life of the loan, then multiply by the number of payments in the tax year.

If you did a cash-out refinancing, your tax deduction for the points will be subject to the same limitations as mortgage interest, i.e. did you use the cash-out to improve your home? If you’ve refinanced before and have points you haven’t yet deducted, these can be deducted when you refinance for the second time.

The good news is the deductibility of penalties and fees is relatively straight forward. Any prepayment penalties to get out of your old mortgage are deductible as interest in the year you pay it! However, any fees paid to get the new loan are not deductible.

You’ll probably want to act quickly. Industry insiders speculate that as the pandemic fades, rates will rise, so hop on this bus before it leaves.

If you have questions, contact your Henry+Horne professional advisor.

Melinda Nelson, CPA, Partner, specializes in tax planning and compliance involving closely-held businesses and their owners. She also practices in estate, gift + trust planning and taxation. You can reach her at MelindaN@hhcpa.com or (480) 839-4900.