Limits On Mortgage Interest Deductions For Refinancers & Cash Buyers

Recent existing home sales reports remind us that cash buyers are on the rise. In May, 30% of existing home sales were all-cash deals, down only slightly from 31% in April, and a record 35% in March.

Is it more beneficial to pay cash for a home? Depends on your expected time horizon in the home, and what return you could otherwise get for that cash. Here are some things to consider. Refinancers, pay attention too: if you’re increasing your loan balance, you WON’T increase your loan interest deductions.

(1) Current rates are 4.625% for a 30yr fixed or 3% for a 5yr ARM. If you’re in a 33% tax bracket, your after-tax 30yr rate is 3.09% and your after-tax 5yr rate is 2.01%.

(2) If you financed at those rates and invested the cash, can you beat 3.09% or 2.01% investment returns after fees and taxes?

(3) If you’re paying cash with intent to finance later to take advantage of mortgage interest deductions, you have two problems:

(i) Mortgage interest deductions are limited to the IRS “acquisition debt” limit. They define deductible debt as debt taken at the time of acquiring the home. If you get a loan more than 90 days after buying the home, mortgage interest isn’t deductible.

(ii) You’d then be doing a cash-out refinance loan instead of a purchase loan. Depending on your equity position, cash-out rates can be as much as .375% higher. Also cash-out loan restrictions might prevent you from taking your desired cash amount back out.

Cash buyers (and refinancers) should think through and research this fine print with mortgage, investment, and tax advisors.