When interest rates are low, many homeowners look at refinancing their homes. Those who refinance at a lower interest rate benefit from lower mortgage payments as well as a lower amount paid over the life of the mortgage. But did you know refinancing could also bump up your tax return?
With most home loans — let's use a fixed loan as an example — the homeowner will pay the mortgage holder (often a bank) a fixed amount each month for the 15 or 30 years of the loan. This payment is divided between money that's applied toward the principal balance (the actual amount of the loan) and money applied toward the interest the institution charges to lend the money.
In the first years, most of the monthly payment is applied toward the interest, with a far smaller amount applied toward the principal. Each month, the equation tips just a little bit the other way. By the end of the mortgage, the homeowner is paying far more toward the principal than toward the interest.
When you refinance your home, this equation resets, and the majority of your monthly payment will again be going toward interest. The principal isn't deductible, but the interest is, so you'll have a larger tax deduction from the higher interest payments. Of course, your new interest rate, how much you still owe on your house and what it is currently worth will determine if this is a wise strategy.