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Don't Get Ripped Off When You Refinance Your Mortgage

Every day I get bombarded by mortgage refinancing ads: TV, radio, email, pop-up & banner ads.

It seems like they're all saying you can roll up your car loan and non-deductible credit card debt or cash out your home's equity into a new bigger, better mortgage. Then they have the legalese guy muttering too quickly to understand: "Talk to your tax professional for deductibility rules" ... or words to that effect.

Of course they know no one will actually do this until after they've refinanced. I think the ads are misleading. The rules aren't really that difficult.

Make sure you understand the tax rules and how it will affect you before you refinance. Most people will not be able deduct all the interest on the mortgage described in these ads.

For the most part, you can only deduct mortgage interest on loans used to buy, build or improve a qualified residence. That means you can refinance the principal of your old loan plus any other loans used to buy or improve your home. If you use your mortgage to cash out funds to pay off other debt, the interest on that principal is not deductible.

Home equity loans that are less than $100,000 (or the fair market value of the home less any outstanding debt, which ever is less) are fully deductible regardless of how the proceeds are used.

In addition, the mortgage interest deduction is limited on mortgages over $1 million. If your loan is over $1 million the IRS provides worksheets to help you figure out what percentage is deductible.

If the original mortgage for your home closed before October 14, 1987, it might qualify as "grandfathered debt" and special rules apply. Take a look at IRS Publication 936, Home Mortgage Interest Deduction for more details.

Oh, and watch out for point on refis. They are not fully deductible in the first year. You must amortize them over the life of the loan.