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How Tax Law Affects Different Types Of Mortgages

What you'll learn: Tax law and its effects on different types of mortgages


PenFed offers mortgages to suit every homeowner, but before you commit, you should familiarize yourself with the different types of mortgages available. Knowing your mortgage options is particularly important when you’re a first-time homebuyer; such knowledge allows you to negotiate to get the right mortgage — and the best deal — from your lender. Knowing more about how tax law affects different types of mortgages will help you be better prepared when it comes time to file your taxes.

If you’re looking for general mortgage advice, we have a video library to help homeowners understand every element of their mortgage. But if you just need to brush up on how the latest tax laws affect mortgages, you’ll find the details below.

Fixed Rate Mortgages

These mortgages have the same interest rate over the life of the loan. They don’t have the lowest interest rates, so you may spend a lot on interest payments over the life of the loan — but your monthly payments will be predictable. This is a fairly standard loan, and has no special tax advantages or disadvantages.

Adjustable Rate Mortgages

An adjustable rate mortgage has an interest rate that fluctuates. These loans have an initial low interest period and then the rate adjusts periodically based on current interest rates. The low introductory rate means you could pay less in interest depending on how often the interest is adjusted and how long you stay in the home. But because your interest rate changes, your monthly payments will change — which will impact both your budget and how much you can deduct from your taxes.

VA Loans

These are mortgages from private lenders, but they’re backed by the Department of Veterans Affairs as they are exclusively for active military members, veterans, and their spouses. They tend to have less stringent credit requirements and lower rates — plus they don’t require a down payment or private mortgage insurance. The lack of PMI is a big advantage with the new tax law, which no longer lets you write off PMI expenses.

Joint Mortgages

A joint mortgage simply means that both you and another person apply for a loan together, and you’re both responsible for repaying it. These can sometimes be easier to qualify for because they consider both applicants in totality: both individuals’ incomes, assets, debts, and credit scores are all considered together. This can help you get approved for a larger loan and make up for a partner with a lower credit score. With a joint mortgage, you can also split the mortgage income tax deduction based on how much interest each party actually paid.

This is a good deal for couples who file their taxes separately, as well as family or friends who buy a house together.

Jumbo Mortgages

Conventional loans limit you to borrowing $647,200 for a mortgage on a single-unit property, or $970,800 in high-cost markets. If that’s not enough to pay for your dream home, you need to get a jumbo mortgage that lets you borrow more. These mortgages typically require a higher credit score and a better debt-to-income ratio.

Tax-wise, it’s best to avoid loans higher than $750,000 (or $375,000 if you’re married filing separately), because you won’t be able to deduct all of your mortgage interest from your taxes

Mortgage Modifications

A mortgage modification changes the terms of your original loan, usually due to financial hardship. Changes could lower the interest rate, convert to a fixed rate, extend the term, postpone payments, or even forgive a portion of your debt. If your lender forgives some of your debt, it typically has tax consequences, requiring you to pay taxes on the forgiven debut.

Home Loan Refinance

Refinancing means taking out a new loan with different terms to pay off your existing mortgage. This could help lower your interest rates and reduce monthly payments, though you’ll have to pay closing costs on the new loan. Because of changes in the TCJA, your tax liability will change if you have a loan that goes over the current limit of $750,000 (or $375,000 if you’re married filing separately), preventing you from deducting mortgage interest on debt in excess of those numbers. Existing loans are grandfathered in on previous rates of up to up to $1 million (or $500,000 if you’re married filing separately). Refinances of grandfathered loans that don’t increase the principal balance will keep your grandfathered status as well.

Beyond that, your tax benefits will stay the same: you can write off interest and property taxes (up to a certain amount) as well as any points you bought to reduce your interest rate.

Home Equity Loans and Lines of Credit

These are loans or lines of credit that use your home equity to give you easy access to cash. Because they typically have lower interest rates, they’re great for paying down debt, financing college education, or paying for a home improvement project. However, the TCJA prevents you from deducting the cost of interest on a home equity loan or a home equity line of credit unless it’s used for home improvement.

While you can still spend the money on anything, the total cost of borrowing will be higher if you aren’t using the money for home improvement.

Construction Loans

These loans are specifically to finance building a new home. They’re typically short term with a variable rate, and during the construction period you only have to pay interest, making them a good way to start building. You can deduct mortgage interest on a construction loan, following the same rules as an ordinary mortgage, as long as you move into the house within 24 months of getting the loan.

Second Home Mortgage

All of the tax breaks that are available for a first home are available for a second home, with the same limits. However, be aware that your second home must be a true second home — not a rental property — to qualify for any home mortgage deductions. You can rent your home out for up to 14 nights, but no more if you want to take traditional homeowner deductions.

If you have a second home that is entirely for rental, you can deduct costs as business expenses (form 1040 Schedule E), but not as typical mortgage interest expenses.

Mortgage Investing

If you’re investing in real estate to rent or to flip, you’ll find getting a mortgage is more expensive. Mortgages for investment properties typically require a larger down payment — think of 20% as a minimum — often with higher interest rates and credit score requirements.

Tax Deductions for Rental Property

Investment properties also have different tax implications, though there are many potential write-offs. Look at these potential tax savings:

●      Deducting mortgage interest, though it must be claimed as part of the expenses related to the property on form 1040 Schedule E rather than with your home mortgage interest deduction.

      Deducting business expenses, like advertising and maintenance costs, again, on form 1040 Schedule E. These expenses must typical for the rental industry to be deductible.

●      If you’re losing money renting a property and you aren’t a real estate professional, you may be able to write off some of your losses.

●      Depreciate the cost of the structure (but not the land it’s on), letting you deduct a portion of the cost off your taxes annually.

But investment property makes money, too, and that must be reported as income. If you sell an investment property, it will also typically qualify for capital gains taxes, or short-term capital gains taxes if you’ve owned the property for less than a year.

Land Purchases

If you’re buying land, you’ll be getting a land loan rather than a traditional home mortgage. Like other kinds of mortgage investing, these loans usually require a larger down payment — anywhere from 20% to 50% — and have a higher interest rate.

The tax implications of purchasing land depend on its purpose. If you’re buying it to build a home, you may be able to write off the interest just like a standard home mortgage (as long as you’ll be moving in within 24 months). If you’re buying as part of an ongoing real estate business, you may be able to deduct interest and other expenses as business expenses.

BONUS read: Mortgage Interest and Tax Deductions For Homeowners.

Consult a tax professional before filing

While we’ve presented the basics, every tax situation is different. Please consult a tax advisor for all of your tax related questions.



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1Rates are updated daily at 10:15am EST. The advertised rates and points are subject to change. The information provided is based on discount point, which equals percent of the loan amount, and assumes the purpose of the loan is to purchase a property with a 30-year, conforming, fixed-rate loan. Loan amount of $400,000; loan-to-value ratio of 75%; credit score of 760; and DTI of 18% or less. The property is an existing single-family home and will be used as a primary residence. The advertised rates are based on certain assumptions and loan scenarios, and the rate you may receive will depend on your individual circumstances, including your credit history, loan amount, down payment, and our internal credit criteria. Other rates, points, and terms may be available. All loans are subject to credit and property approval.