How does Tax Reform affect Refi with Cash out?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
RetiredCSProf
Posts: 167
Joined: Tue Feb 28, 2017 4:59 pm

How does Tax Reform affect Refi with Cash out?

Post by RetiredCSProf » Sun Jan 21, 2018 3:23 pm

I currently have a 15-year mortgage at 4.25% with a remaining balance of about $30K. I am thinking about refinancing with cash out to cover unexpected expenses that have exceeded my emergency funds. If I were in a position to itemize, would all the interest on the new loan be deductible as mortgage interest under tax reform? I realize that interest on Home Equity Lines is no longer deductible under tax reform.

Does it make a difference whether the cash out is used on home improvement or for other expenses? Is there a limit on how much to cash out? I am single. I currently file as head of household, but will lose that status in two years, and revert to single.

It's likely that I would be able to pay off the mortgage in a couple years, so the deductibility of the mortgage interest may not be an issue.

mhalley
Posts: 6165
Joined: Tue Nov 20, 2007 6:02 am

Re: How does Tax Reform affect Refi with Cash out?

Post by mhalley » Sun Jan 21, 2018 4:42 pm

I am not sure about the new law.
But converting other types of debts into a mortgage is seldom a good idea unless there is no other way to get the money. You put your home at risk, there can be closing costs, etc.
Last edited by mhalley on Sun Jan 21, 2018 4:47 pm, edited 2 times in total.

User avatar
grabiner
Advisory Board
Posts: 22906
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: How does Tax Reform affect Refi with Cash out?

Post by grabiner » Sun Jan 21, 2018 4:44 pm

Home acquisition debt is deductible; this is debt taken out to buy, build, or improve your home, or refinancing of this debt. If you take a cash-out refinance of a loan you used to buy your home, the amount of the old mortgage is home acquisition debt; any balance added to the loan is only deductible if you use it to improve your home.

Home acquisition debt on a new loan is deductible up to a total loan balance of $750K (used to be $1M, and still is on existing loans and refinances of them). Thus, if your current mortgage balance is $750K, and you do a cash-out refinance, you cannot deduct the interest on the loan above $750K even if you use it to improve your home.
Wiki David Grabiner

DrGoogle2017
Posts: 1322
Joined: Mon Aug 14, 2017 12:31 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by DrGoogle2017 » Sun Jan 21, 2018 6:29 pm

As long as the new mortgage is still under $750k then you are still ok.

RetiredCSProf
Posts: 167
Joined: Tue Feb 28, 2017 4:59 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by RetiredCSProf » Sun Jan 21, 2018 6:52 pm

grabiner wrote:
Sun Jan 21, 2018 4:44 pm
Home acquisition debt is deductible; this is debt taken out to buy, build, or improve your home, or refinancing of this debt. If you take a cash-out refinance of a loan you used to buy your home, the amount of the old mortgage is home acquisition debt; any balance added to the loan is only deductible if you use it to improve your home.
I was confused by this wording in the tax reform bill:
“(I) IN GENERAL.—In the case of any indebtedness which is incurred to refinance indebtedness, such refinanced indebtedness shall be treated for purposes of clause (i)(III) as incurred on the date that the original indebtedness was incurred to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness."

So then it says that I can continue to itemize the interest on the portion of the new loan that equates to the balance of the old loan before I refinanced, that is, $30K, in this case, and does not refer to the original amount of the old loan. If I take cash out, I can deduct the interest only on the cash portion used for home acquisition debt.

The cash would be used on non-acquisition expenses and I am uncertain how much cash I will need. With that in mind, I think I would rather take a home equity line instead of refinancing; otherwise, I would need to keep track of what portion of the interest on a refi is deductible. The interest rate on an equity line is currently only slightly higher than a refi, albeit adjustable, but I can draw the amounts needed incrementally.

A discussion of whether it makes sense for me to take a loan at all would be fodder for a different thread, but basically it comes down to the following choices: (1) withdraw from my tIRAs an amount that exceeds my RMD; (2) represent myself in court; or (3) borrow money to continue paying my attorney for his time. My legal experience is limited to having sat on a jury a couple times and watching a few episodes of "Judge Judy"; the opposition will have legal representation.

MathIsMyWayr
Posts: 193
Joined: Mon Mar 27, 2017 10:47 pm
Location: CA

Re: How does Tax Reform affect Refi with Cash out?

Post by MathIsMyWayr » Sun Jan 21, 2018 7:26 pm

grabiner is right. Mortgage interest is deductible to the extent to acquire, build or substantially improve the primary residence. There is a recent article on this very topic by Kitces. It is the responsibility of the tax payer to determine and track over time how much is deductible.
https://www.kitces.com/blog/tcja-home-m ... 8-57128597

hightower
Posts: 512
Joined: Mon Dec 12, 2016 2:28 am

Re: How does Tax Reform affect Refi with Cash out?

Post by hightower » Sun Jan 21, 2018 7:28 pm

RetiredCSProf wrote:
Sun Jan 21, 2018 3:23 pm
I currently have a 15-year mortgage at 4.25% with a remaining balance of about $30K. I am thinking about refinancing with cash out to cover unexpected expenses that have exceeded my emergency funds. If I were in a position to itemize, would all the interest on the new loan be deductible as mortgage interest under tax reform? I realize that interest on Home Equity Lines is no longer deductible under tax reform.

Does it make a difference whether the cash out is used on home improvement or for other expenses? Is there a limit on how much to cash out? I am single. I currently file as head of household, but will lose that status in two years, and revert to single.

It's likely that I would be able to pay off the mortgage in a couple years, so the deductibility of the mortgage interest may not be an issue.
Nothing in the tax law changes the ability you have to do a cash out refinance on your home.

chevca
Posts: 1918
Joined: Wed Jul 26, 2017 11:22 am

Re: How does Tax Reform affect Refi with Cash out?

Post by chevca » Mon Jan 22, 2018 1:17 pm

Sounds like the emergency is ongoing. The traditional IRAs can't just become an extension of the emergency fund? Seems to me like that would be the best route.

How much would you get cash out on the refi anyway? Not a whole lot I'm guessing. The standard deduction for single and HOH this year is $18k. Would you itemize enough to get any benefit from the mortgage interest deduction? The minimal interest that would be paid on a low rate $75k or however much mortgage likely doesn't even need to be factored into the decision here.

If you don't want to dip into the IRAs to pay these expenses and the loan would likely be paid off in a couple years, I'd go the HELOC route and call it good. Don't complicate this more than needed.

JBTX
Posts: 4107
Joined: Wed Jul 26, 2017 12:46 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by JBTX » Mon Jan 22, 2018 1:33 pm

MathIsMyWayr wrote:
Sun Jan 21, 2018 7:26 pm
grabiner is right. Mortgage interest is deductible to the extent to acquire, build or substantially improve the primary residence. There is a recent article on this very topic by Kitces. It is the responsibility of the tax payer to determine and track over time how much is deductible.
https://www.kitces.com/blog/tcja-home-m ... 8-57128597
Thanks for posting. I didn’t know it was this complicated. This could a real PITA for some. In my case I think I’m ok because all my cash out was used for home remodel, and it likely won’t matter as I probably won’t have enough to itemize most years.

RetiredCSProf
Posts: 167
Joined: Tue Feb 28, 2017 4:59 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by RetiredCSProf » Tue Jan 23, 2018 12:29 am

I have two unknowns:
(1) Cost of additional legal expenses -- I expect the additional cost to be at least $20K but it may be closer to $70K :(
(2) Outcome -- which side will prevail? If I prevail, what will be the size of the award? :beer

I ran some numbers using $70K cash out as an estimate:
(a) tIRAs:
- To cash out $70K, I would need my RMD ($20K) plus $88K extra to cover Fed tax (pushes my marginal rate from 24% to 32%); CA state income tax of 9.3%
- I can limit the distributions to the amount that I need and withdraw incrementally
- If I prevail, I would not be able to "restock" my tax-advantaged retirement funds with the award (I am retired)
- I would lose out on the potential growth of my tIRA, which is likely higher than the cost of mortgage interest

(b) Refi with cash out:
- I can get a 15-year, 1st mortgage of $100K at a fixed rate of about 3.8% (will incur some closing costs)
- My monthly payment will be close to my current payment, but I will be paying interest on the full amount from the start of the loan
- If I prevail in court, I would be able to use the award for a one-time principal reduction on the mortgage
- If I need more than $70K, I would not be able to go back to the well; however, I can still use tIRA for backup
- I may be able to argue that the cash out is home-acquisition related because the legal dispute is over a home improvement project, but I expect that I will take standard deduction for next couple years, anyway.

(c) HELOC:
- I can limit the distributions to the amount that I need and withdraw incrementally
- If I prevail in court, I would be able to reduce or pay off the HELOC
- Interest rate is variable -- tied to prime rate; it starts at 4.5% and is likely to increase; ceiling is 18%
- My monthly payment will increase, since I will still have my first mortgage
- Interest on HELOC is not deductible under tax reform, regardless of how the cash is used

I am leaning toward the Refi option, but am I missing something?

User avatar
grabiner
Advisory Board
Posts: 22906
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: How does Tax Reform affect Refi with Cash out?

Post by grabiner » Tue Jan 23, 2018 12:40 am

RetiredCSProf wrote:
Tue Jan 23, 2018 12:29 am
(a) tIRAs:
- I would lose out on the potential growth of my tIRA, which is likely higher than the cost of mortgage interest
This is the usual decision whether to pay down a loan or invest. The return on low-risk investments in the IRA is less than the interest you pay on your loans. However, you lose tax-deferred growth, and you may lose part of the IRA by having to withdraw it in a larger tax bracket. Therefore, it may be best to cash out from the IRA only up to the top of your current tax bracket. (If you take out a HELOC, you can wait to see the legal outcome, and then pay off part of the HELOC from the IRA.)
(c) HELOC:
- My monthly payment will increase, since I will still have my first mortgage
- Interest on HELOC is not deductible under tax reform, regardless of how the cash is used
The increased monthly payment isn't a serious issue, since you have an IRA for making that payment. (And given the higher rate on the HELOC, you'll probably want to pay it down quickly.)

Interest on the HELOC is deductible if used to improve your home, just as it would be on a refinanced mortgage; however, that doesn't appear to apply in your situation.
Wiki David Grabiner

RetiredCSProf
Posts: 167
Joined: Tue Feb 28, 2017 4:59 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by RetiredCSProf » Wed Jan 24, 2018 8:09 pm

grabiner wrote:
Tue Jan 23, 2018 12:40 am
Interest on the HELOC is deductible if used to improve your home, just as it would be on a refinanced mortgage; however, that doesn't appear to apply in your situation.
Tax Reform disallows the deduction of interest on Home Equity Lines, regardless of how the money is used.

After talking to three different lenders, I have three different answers:
(1) One lender would charge $5K in closing costs for refi with cash out and would not offer me a HELOC because I own a condominium
(2) One lender pushed for a refi with cash out and said closing costs would be the same for the HELOC and refi
(3) One lender pushed for HELOC and would charge only $50 in closing costs

A relative suggested that I use a "balance transfer" with zero interest from a credit card; that is, an unsecured, short-term loan. This idea makes me nervous.

User avatar
grabiner
Advisory Board
Posts: 22906
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: How does Tax Reform affect Refi with Cash out?

Post by grabiner » Thu Jan 25, 2018 1:05 am

RetiredCSProf wrote:
Wed Jan 24, 2018 8:09 pm
grabiner wrote:
Tue Jan 23, 2018 12:40 am
Interest on the HELOC is deductible if used to improve your home, just as it would be on a refinanced mortgage; however, that doesn't appear to apply in your situation.
Tax Reform disallows the deduction of interest on Home Equity Lines, regardless of how the money is used.
I checked the actual text of the law; see page 90, section 11043 The definition of home acquisition indebtedness and home equity indebtedness is not changed, only the deductibility limits (reduced from $1M and $100K to $750K and $0). The definition of the type of debt depends on how the loan was used, not on what it was called; any loan used to buy, build, or improve a home is home acquisition debt.

Here is an explanation of the distinction from Mike Kitces' summary:
Though it’s important to note that “home equity indebtedness” under IRC Section 163(h) is not based on whether the loan is actually a “home equity loan” or “home equity line of credit”. Instead, the determination of “home equity indebtedness” vs “acquisition indebtedness” is based on how the mortgage proceeds are used.

Specifically, “acquisition indebtedness” is a mortgage used to acquire, build, or substantially improve the primary residence; “home equity indebtedness” is money used for any other purpose (e.g., for personal spending, refinancing credit cards, paying for college, buying a car, etc.). Thus, a HELOC that is used to build an expansion on a house is still treated as acquisition indebtedness (as it was used for a substantial improvement), while a cash-out refinance of a traditional 30-year mortgage used to repay credit cards will be “home equity indebtedness” for the cash-out portion.
Wiki David Grabiner

RetiredCSProf
Posts: 167
Joined: Tue Feb 28, 2017 4:59 pm

Re: How does Tax Reform affect Refi with Cash out?

Post by RetiredCSProf » Thu Jan 25, 2018 1:24 am

Thanks for clarifying. Although I could find nothing in the text of the law that made a distinction for HELOC, I read several articles that claimed there was a difference. I thought maybe I had missed something in the text.

Then it may come down to the terms of the loan, e.g., closing costs of HELOC vs refi and how often the interest rate would adjust on the HELOC. I talked to Chase bank today; plan to call Wells Fargo in the morning. I hope my shopping around doesn't hurt my credit score.

Post Reply