If you are considering getting a home loan, there are a number of different ways you can deduct prepaid interest. Some of these options include taking advantage of the points that you are able to deduct, while others involve making sure you have more money upfront.
Basically, using your home equity to buy your first home or to finance a home renovation is a smart move. And, if you take the time to look into your options, you may be pleasantly surprised by the tax benefits.
But, before you sign on the dotted line, be sure to read your paperwork. If you’re unsure, don’t hesitate to consult your accountant.
Let’s get to the core through this guide so that you can make an independent decision. First, get to know more about mortgage points.
Discussed What are mortgage points
Mortgage points are a way to lower your mortgage payment. They also allow you to get tax benefits. Moreover, buying points is a good idea if you plan on staying in your home for a long time.
There are two factors that can determine the savings you get from buying points:
- The interest rate
- The length of your loan
You can use a mortgage point calculator to see how much you’ll save.
The rate reduction will vary based on the lender. It will also depend on the market conditions and your credit history. If you have poor credit, you will likely pay a higher interest rate. However, if you have a high income, you’ll be able to qualify for a low rate.
The interest on the loan will also affect the amount you have to pay for closing costs. These fees can eat into your budget.
Moreover, a down payment will also reduce your payments. Make sure you have enough money to cover emergencies.
What is prepaid mortgage interest?
Prepaid mortgage interest is interest that has been paid in advance of the date that it is due to the lender. It is common when closing a home loan. However, it is not required to cover the entire amount of mortgage interest. Rather, it may be used to protect against higher-than-expected costs.
When is it non-deductible?
Prepaid mortgage interest is not deductible if you pay it before the loan is finalized. Also, if you receive refunds on your prepayment penalties, they must be subtracted from your deductible mortgage interest.
You can deduct mortgage interest on the first $750,000 of your home’s value. This is a new provision that was enacted after the Tax Cuts and Jobs Act passed in December 2017. The old maximum of $1,000,000 is still in effect.
Benefits of Prepaid Interest
Prepaid interest is a common element of the home loan process. It may also be considered in a refinancing scenario. The amount of interest you pay will be largely determined by the terms and conditions of your new loan.
When it comes to prepayment, you have to be selective. For instance, you can save a lot of money by skipping a few payments on your principal. However, you may have to make your loan’s newest version. Thus, it’s best to be aware of your options.
Buying a new house can be a daunting task. Fortunately, there are several tricks of the trade to ensure a smooth and stress-free transaction. For example, you can find a lender who will provide you with an estimate of your home’s approximate value. This will make it a lot easier to budget and stay within your means.
How to Deduct Prepaid Interest or Points?
Prepaid interest, as the name implies, is interest paid in advance of the loan’s maturity. While the interest might be tax deductible, it is not a tax credit.
How to be eligible?
In order to qualify for a deduction on home mortgage points, you must meet certain criteria.
- First, the points must be paid when obtaining your loan.
- Second, the points must be used to reduce the interest rate of the loan and not for any other purpose.
- Third, the points must be considered as “points” by your lender and noted on your loan documents.
- Fourth, the points must represent prepaid interest and can be deducted in the same year as paid.
- Fifth, you must meet certain income requirements in order to deduct the full amount of mortgage points from your taxes.
- Finally, to qualify, you must make a substantial down payment and live in the home for at least a decade.
Suppose you believe you may qualify for a deduction on home mortgage points. In that case, it is important to consult with a qualified tax professional to ensure that you have met all of the criteria and are eligible.
Your tax professional will be able to provide guidance on which documents need to be submitted with your tax return in order to claim the deduction. They can also provide information about any additional documentation that may be required by the IRS.
If all else fails, you can opt for a refinancing deal from your existing lender. But, if you have a home equity line of credit, you will have to make the decision to put the cash to good use.
Will a lender grant you a loan?
To be eligible for a prepaid interest tax credit, a loan must be for less than 30 years. The prepaid cost can’t exceed the value of the loan. Aside from the aforementioned requirements, there are other factors to consider.
For example, should the loan be used to buy or build a home or both? As such, a lender might require a down payment and upfront fees. Also, the home must be used to purchase or rebuild a principal residence.
Lastly, if the aforementioned requirements aren’t met, a lender might refuse to extend the loan. However, a lender might grant you multiple loans, provided you can prove you’re a responsible borrower and can repay the loan with cash, not debt.
In short, it is not impossible to obtain a prepaid interest tax credit, but you might want to be a little more prepared.
How to save money for prepaid point approval?
The best way to save money on your upcoming home loan is to get a preapproved mortgage. As with most things, it’s a good idea to do your due diligence before signing any deal.
If you’re a new homeowner, you will have to make many purchases in the first few weeks of your new abode. Taking the time to shop around and compare loan offers will pay dividends later in the game.
Having a preapproved home loan will also ensure that you don’t overpay for features you don’t want. Fortunately, you can count on your friendly neighborhood bank to make the process as easy as possible.
Takeaways…
Taking the extra effort to qualify for a preapproved mortgage can mean the difference between a stress-free first few weeks in your new pad and a hefty tax bill later in the year. For more details, check out our new money management guide.
To sum up, qualifying for a deduction on home mortgage points requires you to meet certain criteria. It is important to consult a tax professional prior to submitting your taxes in order to ensure that you have met the requirements and are eligible for the deduction. Doing so can save you money and help you reduce your overall tax burden.