If you’ve refinanced lately, congratulations. You’ve undergone the tough scrutiny of a mortgage lender and have been rewarded with a lower monthly mortgage bill.
Come April, though, you may wonder if the hassle of refinancing was really worth it. That’s because shaving interest off your mortgage means you’ll take a smaller interest deduction when calculating your income tax.
Indeed, IRS stats show a sizable decline in the amount of mortgage interest Americans have deducted from their taxes since the housing boom of the past decade.
To avoid a nasty surprise, “Figure out what your tax liability will be with the new mortgage rate,” says Karl Fava, a Certified Public Accountant based in Dearborn, Mich.
For instance, Fava explains, if you are paying $3,600 less annually in mortgage interest and are in a 20-percent tax bracket, “you’ll be paying $720 more in income tax.” That’s because your taxable income can no longer be reduced by that $3,600, so you’ll pay a 20-percent tax on $3,600, or $720.
Be prepared for a bigger tax bill by either saving more or adjusting the amount of tax withheld from your paycheck,” Fava says.
If you do the latter, “Ask the human resource people [at your workplace] for a W4 form, which has a line that indicates an additional amount to be withheld.”
Don’t regret refinancing, though, Fava says: “I’ve heard clients say, ‘Isn’t mortgage debt good?’”
He explains that yes, you get a deduction, but you pay out more dollars than saved in taxes.
For instance, “The higher tax you’ll pay is much less than the dollars you’ll be saving in interest payments.”
In fact, Fava says today’s low rates represent an opportunity to get rid of your mortgage faster by refinancing into a 15- or 20-year loan, instead of the traditional 30-year mortgage.