Mortgage Refinance

Should You Pay Off or Refinance Your Mortgage? This New Tax Law Could Change Everything

The federal Tax Cut and Jobs Act signed into law in December 2017 was a big deal for homeowners. So big that it could motivate some to refinance their mortgage or pay it off altogether.

But the law made a number of changes that could affect taxpayers who buy or already own a home. So with this new law in mind, is it best to pay off or refinance your mortgage?

Let’s take a look at three key changes you’ll want to consider to help you answer that question.

1) Higher standard deduction

Taxpayers who don’t itemize their deductions on Schedule A normally take the standard deduction instead.

For the 2017 tax year, standard deductions were $6,350 for single taxpayers, $9,350 for heads of households, and $12,700 for married couples filing jointly.

The new law raised the standard deductions to $12,000 for single taxpayers, $18,000 for heads of households, and $24,000 for married couples filing jointly. (Source)

Mortgage interest paid for a principal residence is a Schedule A deduction.

2) The cap on the deductibility of SALT

State and local income taxes, or state and local sales taxes, plus property taxes, used to be 100% deductible. These taxes are sometimes abbreviated as SALT.

Homeowners benefit from deducting mortgage interest and property taxes to the extent that they exceed the standard deduction”

The new law put a cap of $10,000 on SALT deductibility.

The cap is per tax return, not per person, so it’s the same for singles, heads of households, and married couples filing jointly. For married couples filing separately, the SALT cap is $5,000.

A married couple who maxed out their SALT deduction would now need an additional $14,000 of other deductions to exceed the standard deduction.

“Homeowners benefit from deducting mortgage interest and property taxes to the extent that they exceed the standard deduction,” says Joe Parsons, sales manager at Pinnacle Capital Mortgage in Dublin, Calif.

3) Mortgage interest deduction

Two other changes in the new tax law are:

Mortgage interest paid for new loans taken out after Dec. 14, 2017, can be deducted only up to a loan amount of $750,000.

If an older loan is refinanced, interest paid can be deducted up to a loan amount of $1 million, but only if the new loan isn’t larger than the refinanced loan. (source)

Interest paid for home equity loans, and home equity lines of credit (HELOCs) cannot be deducted until 2026 unless the funds are used to make substantial improvements to the home.

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What this means for homeowners

The biggest impact of these changes is that homeowners now need a larger dollar amount of itemized deductions to make itemizing a better strategy than taking the standard deduction.

For some, the benefit of itemizing will disappear, making mortgage interest and SALT irrelevant for income tax purposes.

Here’s an example:

For the 2017 tax year, if a married couple paid mortgage interest of $15,000 and property tax of $3,000, their itemized deductions would have totaled $18,000, or $5,300 more than their standard deduction.

Itemizing would have lowered their tax bill. How much they would have saved would depend on their income tax bracket.

Now, with the standard deduction raised to $24,000, this couple wouldn’t benefit from itemizing, despite their $18,000 of itemizable deductions. Instead, the standard deduction would lower their tax bill more.

The upside is that taxpayers who switch to the standard deduction will no longer need to keep track of all the expenses they used to deduct on Schedule A.

4 options for homeowners

Homeowners whose itemized deductions no longer exceed the standard deduction have four options to consider:

  1.  Keep the existing mortgage, and take the standard deduction.
  2. Pay off the mortgage, and eliminate the interest expense since there’s no longer a tax benefit to offset it.
  3. Refinance into a 15-year mortgage year to accelerate interest payments, creating a large itemizable deduction. The monthly payment may be higher, the loan will be paid off sooner, and the interest paid could reduce the homeowner’s tax bill.
  4. Refinance into a bigger mortgage, again to create a larger deduction. The monthly payment probably will be higher, and cash out will be available for other needs or wants.

Which option is the best?

The answer isn’t obvious. Many homeowners don’t have enough cash to pay off their mortgage or can’t afford a higher payment. Some might not want to incur the cost to refinance or increase their debt just to recapture a lost income tax deduction.

As Parsons says, taxpayers’ decision to refinance or pay off their mortgage “should be driven by the economics alone, not the tax benefits they once had.”

If refinancing makes sense for you for other reasons, now might be a good time to research your options.

Compare mortgage refinance lenders side-by-side to find your best option.