Home equity, which is the difference between the current mortgage balance and the home’s total value, can be used as a loan with a cash-out refinance. For example, if your home is worth $200,000 and your mortgage is $150,000, you have $50,000 of equity.
You can access that equity through cash-out refinances and use it as a low-interest loan to pay for everything from home improvements to college tuition to medical expenses. There are taxes to consider, so it’s not “free money.”
Does cash out refinance get taxed?
With a cash-out refinance, your current mortgage is replaced with a larger one that includes the value of the equity you are taking out and any closing costs you choose to include in the new balance.
You do not have to pay income tax on the money you get since the IRS does not consider the cash-out to be income, but there are specific requirements you must meet to qualify for the mortgage interest deduction.
If you use the cash withdrawn to make capital improvements to your home, you can deduct the interest you pay on the new mortgage from your taxable income. Permanent additions and home improvements that increase the value of your home, extend its useful life, or adapt it for a new use are usually projects that qualify for the deduction.
To ensure the projects you are working on qualify, consider talking to a tax expert. Keep receipts, and other records related to your initiatives-you’ll need them to show how the funds were used when you file your taxes.
What can you do with the refinancing?
In theory, you can use a cash-out to pay off high-interest credit card debt, set up a retirement account, pay for a child’s college education, or make home improvements.
To make more money and possibly increase tax deductions, many real estate investors use the money from a cash-out refinance. The common use to get can be:
Making renovations to add value and increase rent
Examples of modifications, renovations, and changes made to rental properties to add value and increase potential rental income include:
- To increase value and defend a higher monthly rent, renovate the kitchen or bathrooms
- By including a bedroom or converting a garage, attic, or basement into more living space, you can increase the amount of rentable square footage
- Add insulation, new windows and doors, programmable thermostats, and other energy-efficient upgrades
- Install a new heating and cooling system in place of an outdated one
- To make the property safer for tenants, build a new fence
- Redesign the front yard to increase the home’s curb appeal
Acquire a new rental property
Acquiring a new property is a great way to refinance money for better long-term tax and financial benefits. However, you should seek advice from experts in the field.
From the moment you decide to apply for a mortgage or loan for a property, it is advisable to have a legal advisor ready to offer you the necessary help.
María Laura Landino is a journalist who graduated from Boston University with more than four years of experience in the financial sector. He has been responsible for several research papers published by major universities.
Content Manager of allaboutgroup company. You will find me in job and Finance sections.