mortgage refinancing

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A cash-out refinancing loan is treated differently by the IRS than a traditional mortgage. Although you receive a lump sum of cash, cash-out refinancing is considered a form of debt restructuring, and you do not pay taxes on the cash you receive.

With cash-out refinancing, you cash out a percentage of the equity that you have accrued in your home and replace your existing mortgage with one with a higher principal. You can use the cash for any reason, such as consolidating debt, paying for home renovations, or unexpected medical expenses.

Here’s what you should know about cash-out refinancing and the tax implications.

How Cash-Out Refinancing Works

When you refinance your mortgage, you cash out equity. Equity is the difference between your current mortgage balance and the value of your home today. Let’s say your home is worth $300,000 and the balance on your mortgage is $150,000, you have $150,000 in home equity.

A lender typically requires you to keep at least 20% of the value of your home in equity. In the above case, you would leave $60,000 in equity and have $90,000 to cash out. Your mortgage lender would also charge around 1% in closing costs.

First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.

The Tax Implications of Mortgage Refinancing

A cash-out refinancing loan is treated differently by the IRS than a traditional home loan because it is considered a form of debt restructuring. You do not pay tax on the money you receive in cash, and you might also be able to deduct some of the interest you pay on that cash from your taxes.

Here’s a closer look at the tax implications of a cash-out refinancing loan.

Is a Cash-Out Refinance Taxable?

Because the IRS considers a cash-out refinance to be a form of debt restructuring, the cash you receive is considered a loan, not income, and is not taxed. In addition, you could receive additional tax benefits depending on how you spend the money you receive.

If you use the cash to increase the value of your home, such as putting on a new addition or replacing your heating or cooling system, you can claim the interest that you pay on the loan as a tax deduction.

Before you do this, however, consult a tax professional to make sure that the work qualifies. Simple repairs like painting or general maintenance do not qualify for tax deductions. You will also have to keep meticulous records and save receipts documenting what you spend so that you can prove your case when you file your taxes.

Requirements for Interest Deductions on a Cash-Out Refinance

Capital improvements to a property that increase its value will qualify for an interest deduction. Examples could include a new addition, a security system, or a new swimming pool. General maintenance and repairs will not qualify, nor can you deduct the interest you pay on the loan if you spend the money on a vacation, medical bills, or credit card debt.

How to Make a Cash-Out Refinance Tax-Deductible

Below is a list of home improvements that qualify for the interest deduction.

Qualifying Home Improvements

•   Renovating or adding on an addition, such as a garage or a bedroom

•   Putting in a swimming pool

•   New fencing

•   New roof

•   New heating or cooling system

•   Installing efficient windows

•   Installing a home security system

Improving your property’s value means you can also save money if you sell your home. Capital home improvements count toward the total amount you spent on the property and can potentially lessen your capital gains tax liability when you sell your home.

Deductions for Adding a Home Office

Adding a home office to your home is a capital improvement that qualifies for the interest deduction on a cash-out refinancing loan. There are also additional potential tax benefits to adding a home office for small businesses or the self-employed.

How Home Offices Can Impact Your Taxes

You can deduct the interest on your cash-out refinancing loan if you use the money to add a home office, because it will increase the value of your home and is considered a capital improvement. If you are a business owner or self-employed, you could also qualify for the home office deduction on your federal taxes.

The home office deduction is a benefit that allows you to claim a percentage of what you pay on your loan as a business expense. You must use the designated office space for business purposes only, and it cannot be used as a spare bedroom or family space or it will not qualify. Also, your home office must be the primary place where you conduct business.

Recommended: What to Know Before You Deduct Your Home Office

Tax Implications of a Cash-Out Refinance for Rental Property

Rental income is considered personal income by the IRS. If you use the capital from a cash-out refinance to improve or repair a rental property, the expenses are tax-deductible. Also, interest, closing costs, and insurance paid on a rental property can be deducted from your income as business expenses.

What Are the Limitations for Interest Deduction with a Cash-Out Refinance?

For the 2022 tax year, single filers and married couples filing jointly could deduct mortgage interest up to $750,000. Married taxpayers who file separately could deduct up to $375,000 each. (The limit is higher for debts incurred prior to December 16, 2017: $1 million or $500,000 each for married couples filing separately.)

Can You Deduct Your Mortgage Points?

Mortgage points, also known as discount points, are fees you pay a lender upfront so that you can pay a lower interest rate on your loan. One point is equal to 1% of your mortgage loan. With a cash-out refinance, you cannot deduct the money you paid for points in the year you refinanced until after 2025. But you can spread out the cost throughout the loan. That means if you accumulate $2,500 worth of mortgage points on a 15-year refinance, you can deduct around $166 per year throughout the loan.

Risks of a Cash-Out Refinance

Cash-out refinancing is a risk. You are taking on a larger loan than your original home mortgage, which means that your monthly mortgage payment will increase unless interest rates are lower than when you applied for your current mortgage. If your payments are higher and you can’t keep up with them, you could be at greater risk of foreclosure.

Alternatives to a Cash-Out Refinance

Two financing alternatives that also use equity in your home are a home equity loan or a home equity line of credit (HELOC).

A home equity loan is a second mortgage for a fixed amount that you repay over a set period while keeping your original loan. The payments include interest and principal, just like a traditional mortgage, but the interest rate may be higher than a primary mortgage. This is because the primary lender is paid first in the event of foreclosure, so the secondary lender takes on more risk.

A home equity line of credit (HELOC) is also a second mortgage but with a revolving balance. That means you can borrow a certain amount, pay it back, and then borrow again. As with a credit card, your payments are based on how much you use from the line of credit, not on the available credit amount. If you don’t need to borrow a large sum, this might be a cheaper option than cash-out refinancing because a HELOC tends to have a lower interest rate.

Recommended: Home Equity Loans vs HELOCs vs Home Improvement Loans

The Takeaway

Cash-out refinancing is a way to access the equity in your home and use it to pay for expenses, though it does mean taking on increased debt. The cash from this type of mortgage refinancing can be used any way you like, such as to pay for home renovations, college, or unexpected medical expenses.

When you opt for cash-out refinancing, your original mortgage is replaced by a larger mortgage. If interest rates are lower than when you took out your original mortgage, your monthly payments may go down, but it will take you longer to pay off the loan. Depending on how much cash you need, you can also consider a HELOC or a home equity loan to obtain the money you need.

Turn your home equity into cash with a cash-out refi. Pay down high-interest debt, or increase your home’s value with a remodel. Get your rate in a matter of minutes, without affecting your credit score.*

Our Mortgage Loan Officers are ready to guide you through the cash-out refinance process step by step.

FAQ

Is cash-out refinance tax-deductible?

Some of the interest you pay on a cash-out refinancing loan might be tax deductible if you use the money to make capital improvements on your home and you keep meticulous documentation to prove it. It’s best to consult with a tax professional to make sure the improvements you do on your home qualify for the deduction.

Do you pay taxes on a cash-out refinance?

No. The funds you receive from cash-out refinancing are not subject to tax because the IRS considers refinancing a form of debt restructuring, and the money isn’t categorized as income.

How do I report a cash-out refinance on my tax return?

You don’t need to report the cash you receive from a cash-out refi as income, so the refi would only show up if you record the interest you are paying on the new mortgage on an itemized return.

What are the tax implications of a cash-out refinance on a rental property?

Rental income is taxed as personal income by the IRS. The good news is that if cash from a refinancing is used to improve or repair a rental property, the expenses are tax-deductible. Also, closing costs, interest, and insurance paid on a rental property may also be deductible from your income as business expenses.

How does the timing of a cash-out refinance affect my taxes?

As long as you meet the requirements for capital improvements, you can deduct the interest paid on your refinanced loan every year that you make payments throughout the life of your refinance loan. So, if you refinance your mortgage to a 15-year term, you must spread your deductions over the 15 years. However, you can only deduct the interest you pay each year, and the amount of interest paid will become less as the loan matures and you pay more toward the principal.

Photo credit: iStock/Jun

*Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

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Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Source: sofi.com

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If you were shopping for a mortgage and a bank offered you an extra low rate on a 1-year adjustable-rate mortgage, you’d probably scoff at the idea.

Why on earth would anyone take out a high-risk ARM with a very limited fixed period at a time when fixed mortgage rates have rarely been lower?

To save lots of money, of course…

A new analysis put together for the WSJ by Lender Processing Services revealed that jumbo lenders are originating a large share of 1/1 ARMs, those that are fixed for the first year before becoming annually adjustable.

In fact, more than 75% of private-label jumbos ARMs originated this year were 1/1 ARMs, as opposed to say 30-year fixed mortgages, which are extremely well-liked by the rest of the population.

If you look at mortgage refinancing alone, the numbers are even more 1/1 ARM-happy. In fact, 96% of private-label jumbo ARMs were 1/1 ARMs in August, up from 84% back in January.

So those with jumbo loans are increasingly going with very short-term ARMs, despite the 30-year fixed hovering close to 4% and the 15-year fixed averaging close to 3.25%.

What’s the Upside to the 1-Year ARM?

The path of the 1-Year ARM since 1985.

  • You might be wondering why someone would choose a 1-year ARM
  • Seeing that it becomes adjustable after just 12 months
  • But when we’re talking about a jumbo loan amount
  • The savings in year one alone can be worth it, not to mention what the borrower does with the excess money during that time

Well, these 1/1 ARMs have start rates around 2.5%, which will save jumbo borrowers some serious cash.

Let’s say we’re talking about a $1 million dollar loan amount. If the homeowner is conservative and goes with a 30-year fixed set at 4%, they pay $4,774.15 per month.

If they opt for a 1/1 ARM with a start rate of 2.5% instead, they’d be looking at a monthly mortgage payment of $3,951.21 for an entire year.

Over the first year alone, this homeowner would save nearly $10,000, or about $825 per month.

Once the loan adjusts after a year, it would be based on the margin, say 2.25%, and the index, which if tied to LIBOR, would be dirt-cheap, still under or close to 3%.

So this hypothetical jumbo borrower could save thousands and thousands of dollars, and invest the excess in the stock market or wherever else to gain a better return.

The 1-Year ARM Is Not for Everyone

  • The one-year ARM clearly isn’t the best loan choice for the majority of the population
  • Seeing that once it becomes adjustable it could reset significantly higher
  • This isn’t a problem for extremely wealthy people
  • Who always have the option to just pay off the loan with cash or refinance it again

Of course, if and when mortgage rates do rise, this strategy wouldn’t make a lot of sense, and could actually burn the homeowner in question.

Sure, there are caps that limit how much an ARM can rise during a certain period, such as a year, but it wouldn’t take long for the 1/1 ARM to exceed the rate of a fixed mortgage at these levels.

However, jumbo borrowers don’t seem to be deterred. Even Facebook founder Mark Zuckerberg reportedly has a short-term ARM, though there’s a glaring difference between him and the rest of us.

He can pay off the loan in its entirety pretty much whenever he wants to. And he probably will once rates finally rise to unattractive levels.

For the rest of us, opting for a 1/1 ARM carries a lot of risk. Once rates rise, you might have trouble actually making the higher mortgage payment each month.

Additionally, for those with smaller loan amounts, the difference in monthly payment between a short-term ARM and a fixed mortgage probably isn’t all that significant, hardly worth the risk.

Not only that, but you could get caught out if you simply plan to refinance once rates rise. A refinance is never guaranteed. You could lose your job, see a drop in income or credit score, or get denied for a countless number of other reasons.

This explains why most borrowers opt for long-term fixed mortgages and/or hybrid ARMs with a reasonably long fixed period, such as the 5/1 ARM and the 7/1 ARM.

Both provide initial rate discounts, but remain fixed for five and seven years, respectively, which makes them a lot less speculative.

Read more: Fixed Mortgage vs. Adjustable Rate

Source: thetruthaboutmortgage.com

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Homebuyers choose the number of years they’d like their mortgage to last. The 30-year fixed-rate mortgage is by far the most popular, followed by the 15-year fixed-rate mortgage, but terms of 10, 20, 25, and even 40 years are available.

The term that will work best for each borrower largely depends on the monthly mortgage payment they can handle and how long they plan to keep the property.

What Is a Mortgage Term?

The term is the number of years it will take to pay off a home loan if the minimum payment is made each month.

During the pandemic, homeowners have kept their homes for eight years on average, according to the 2021 National Association of Realtors® Profile of Home Buyers and Sellers. Knowing how long you plan to stay in your home can affect the type of home loan that fits your situation when you shop for a mortgage — short or long term, fixed or adjustable interest rate?

How Mortgage Terms Work

For fixed-rate home loans, payments consist of principal and interest, with a fixed interest rate for the life of the loan. With mortgage amortization, the amount going toward the principal starts out small and grows each month, while the amount going toward interest declines each month.

A shorter term, conventional loan generally translates to higher monthly payments but less total interest paid, and a longer term, vice versa. A shorter-term loan also will have a lower interest rate.

This mortgage calculator tool includes an amortization chart that shows how payments break down over a fixed-rate loan term. And total interest paid is predictable.

Most adjustable-rate mortgages (ARMs) also have a 30-year term. You can’t know in advance how much total interest you will pay because the interest rate changes.

How Long Can a Mortgage Term Be?

A few lenders out there offer 40-year mortgages. Qualifying is more difficult, and the rates are the highest among fixed-rate loans, while ARMs can be unpredictable.

The long term means a borrower will make the lowest possible monthly payments but pay more over the life of the loan than any other.

Fixed-Rate Mortgages vs Adjustable-Rate Mortgages

When you’re first choosing mortgage terms or looking at different types of mortgages, start with one of the basics.

A fixed-rate mortgage is exactly what it sounds like. You lock in an interest rate for the entire term. If market rates rise, yours will not.

An adjustable-rate mortgage is much more complicated. An ARM usually will have a lower initial rate than a comparable fixed-rate mortgage, and a borrower may be able to save significant cash over the first years of the loan.

Recommended: Adjustable Rate Mortgage (ARM) vs. Fixed Rate Mortgage

But a rate adjustment can bring a spike in mortgage payments that could be hard or impossible to bear. With the most common variable-rate loan, the 5/1 ARM, the rate stays the same for the first five years, then changes once a year.

An interest-only ARM has an upside and downside. You’ll pay only the interest for a specified number of years, when payments will be small, but you will not be paying anything toward your mortgage loan balance.

An ARM may suit those who are confident that they can afford increases in monthly payments, even to the maximum amount, or those who plan to sell their home within a short period of time.

ARM seekers may want to apply for more than one loan and compare loan estimates. It’s a good idea to know the answers to these questions:

•   How high can the interest rates and my payment go?

•   How high can my interest rate go?

•   How long are my initial payments guaranteed?

•   How often do the rate and payment adjust?

•   What index is used and where is it published?

•   Will I be able to convert the ARM to a fixed-rate mortgage in the future, and are there any fees to do so?

•   Can I afford the highest payment possible if I can’t sell the home, or refinance, before the increase?

Looking to take out a mortgage?
See what SoFi Mortgages has to offer.

Comparing 15-Year and 30-Year Mortgages

Clearly, paying off a mortgage in 15 years rather than 30 sounds great. You’ll get a lower rate, pay much less total interest, and be done with house payments in half the time. The catch? Higher monthly payments.

Here’s an example of how a 30- and 15-year fixed-rate mortgage might shake out, not including property taxes and insurance and any HOA fees.

30-Year vs. 15-Year Fixed-Rate Mortgage

Type Loan Specs Rate Payments Total Interest Paid
30-year Appraised value: $375,000
Down payment: $75,000
Loan size: $300,000		 4% Mortgage payment: $1,432 $215,607
15-year Appraised value: $375,000
Down payment: $75,000
Loan size: $300,000		 3.2% Mortgage payment: $2,101 $78,130

There’s a reason that the 30-year fixed-rate mortgage reigns supreme: manageable payments that ideally leave enough money for emergencies and retirement savings. Borrowers making lower payments can always pay more toward the principal if they want to pay off the mortgage early.

Then again, borrowers with stable finances who can afford the higher payments of a 15-year home loan may find it quite appealing.

The Takeaway

How to pick a mortgage term? Look at your budget, decide how long you plan to stay in the home, and weigh your financial goals and priorities.

Speaking of terms, SoFi offers fixed-rate home loans with a variety of terms to fit your needs.

The SoFi home loan help center also covers mortgage refinancing, which may change an existing loan rate and term.

SoFi rates are competitive, and finding yours takes just minutes.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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Source: sofi.com

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After a few really good years, mortgage refinancing has slipped back to levels not seen since 2008, according to the first quarter refinance report released today by the Federal Housing Finance Agency (FHFA).

The FHFA noted that a total of 370,856 refinances were completed between January and March, including 232,484 via Fannie Mae and 138,372 via Freddie Mac.

That compares to 506,051 total refinances during the fourth quarter of 2013 and nearly 1.4 million during the same period a year ago. Yes, things have slowed down just a bit.

Rates Were a Lot Higher in 2008

Now here’s the scary part – 30-year fixed mortgage rates averaged 6.03% back in 2008.

During the first quarter of 2014, 30-year fixed interest rates averaged less than 4.40%, and yet activity remains at a six-year low. In other words, rates aren’t too high, they’re just not that useful anymore.

Mainly because most of those who could already refinanced, and home sales continue to trickle due to inventory constraints.

Obviously it’s a shame to see low mortgage rates go to waste, but there’s not much that can be done, barring new all-time lows.

HARP Refis Continue to Slip, But Market Share Remains Steady

The story was similar with HARP refinances, which totaled 76,930 during Q1. A total of 46,896 were directed through Fannie Mae and the remaining 30,034 passed through Freddie.

That brought the lifetime total to 3.1 million for the program that originated back on April 1, 2009, not bad, but not quite the 4-5 million originally envisioned.

The HARP share of refinancing was 21% in the first quarter, down from 23% in the fourth quarter but roughly the same as it was a year earlier.

Most of the HARP refinances occurred in the 80-105% LTV band (53,678), followed by the 105-125% LTV band (13,920), and finally the 125+ LTV band (9,332).

In Georgia, 41% of all refinances were completed via HARP, followed by Florida with a 38% HARP-share and Nevada/Michigan with a 33% HARP-share.  They were also pretty popular in Illinois (31% share), Arizona (26%), and Idaho (24%).

This kind of illustrates how bad refinance volume would be without HARP available. These states would lose a major amount of business in a hurry.

And let’s be honest, the pool of eligible borrowers is clearly shrinking, so it won’t be long before HARP is absent from the refinance scene altogether.

The good news is that HARP seems to be accomplishing its mission of reducing mortgage delinquencies.

The chart above displays the percentage of loans that were ever 90 days delinquent after given dates based on whether refinanced through HARP or not, assuming they were eligible.

As you can see, loans refinanced through HARP are displaying considerably lower default rates across the board compared to those where a HARP refinance was available but not pursued.

And now that rates are low again, we might see another uptick in HARP activity. However, Mel Watt made it clear that there will not be a HARP 3, despite many pleas to expand the program further.

Read more: How to refinance when underwater on the mortgage.

Source: thetruthaboutmortgage.com

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For some buyers, it may make sense to buy a home now and refinance it to a lower rate in the future.

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While inflation is cooling, interest rates remain high, which puts a damper on Americans’ plans to buy a home or refinance their existing mortgages. The natural question many homeowners are asking themselves in this economic climate: Should I buy a home now at high rates and refinance later, or should I wait for rates to fall? We posed the question to several real estate and mortgage professionals and educators, and their answers may surprise you.

If you’re considering buying a new home or refinancing your current one it helps to know what rate you may qualify for. Find out here now!

When buyers should buy now and refinance later

Robert Johnson, a professor at Heider College of Business at Creighton University, points out that purchase price and mortgage rate are the two primary financial factors potential homebuyers consider when buying a home, but there’s a critical distinction between the two.

“What many fail to understand is that only one—mortgage rate—can be renegotiated,” says Johnson. “Once a home is purchased, you can’t renegotiate the purchase price. What this means, in my opinion, is that if you find a home you believe is priced attractively, I would be more apt to pull the trigger than if mortgage rates are attractive and home prices seem high. In financial terms, you have optionality for the remainder of your mortgage to renegotiate terms. You don’t have that option with a purchase price.”

As the saying goes, “Marry the home, but date the rate.”

Additionally, you may experience other unique benefits if you buy a home in the current climate. “Buyers who are in the market while interest rates are high may have certain advantages that they otherwise wouldn’t, such as less competition and more negotiating power,” states Afifa Saburi, senior researcher at Veterans United Home Loans. “While they still have the option to refinance, potentially more than once throughout their 15- or 30-year mortgage term, they also have the opportunity to build equity and wealth.”

As with many financial questions, the answer may not be cut and dried, as it will depend on your financial situation and forces outside your control. For example, it’s hard to consider mortgage rates in a financial decision when it’s unclear which direction they will move.

Regarding whether to buy now and refinance later or adopt a wait-and-see approach to , economist Peter C. Earle from the American Institute for Economic Research says it’s hard to predict. “Typically, the rule of thumb is that one wouldn’t finance unless the new mortgage rate to lock in is at least 0.75% to 1% lower than the established rate,” says Earle.

“The Fed has jawboned exhaustively about their intention to keep rates at present levels once their hiking campaign is over, but if the U.S. enters a recession, it’s not at all clear that they won’t drop rates. That’s been their playbook since the Greenspan era,” said Earle, referring to Alan Greenspan, the former chairman of the Federal Reserve of the United States.

Not sure what purchase rate you would qualify for? Explore your rates and options here now to learn more.

When buyers should wait until rates drop back down

No matter when you buy a home, the decision should be based on sound financials, namely, whether you can afford the payments and how long you plan on staying in the home long-term.

Brian Wittman, owner and CEO of SILT Real Estate and Investments, cautions: “I don’t believe in the philosophy that buying now and refinancing later is the best course of action. We’re still not sure of the direction of the housing market, including both property values and interest rates. The problem with this particular philosophy is that buying now and hoping that interest rates go down to make your payment better is bad financial planning. If you can’t really afford the payment now, you’ll be overpaying while you wait and hope for interest rates to drop.”

For existing homeowners, the decision to buy now and refinance later, or wait until mortgage rates fall, may come down to your existing home’s mortgage rate. “In general, I’d suggest not selling or refinancing your home if the rates are higher than your existing mortgage, especially if you want to purchase a new house,” advises Michael Gifford, CEO and co-founder at Splitero.

Check your mortgage refinancing rates here to learn more.

The bottom line

If you’ve decided to take out a mortgage now, but have concerns about locking yourself into a high rate, consider getting a mortgage with a float-down option. This feature allows you to lock in your interest rate while also allowing you to take advantage of a lower rate within a specific period.

Not sure whether to buy a home now and refinance it later, or wait for mortgage rates to drop? It may help to know there are other alternatives worth considering. One option is to make improvements to your home using funds from a home equity loan or home equity line of credit (HELOC). Tapping into your home equity to upgrade your property may increase its value.

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Source: cbsnews.com