With the world mobilizing to fight the spread of the coronavirus, the Federal Reserve has also gotten involved, announcing unlimited quantitative easing and cutting interest rates.
How does this affect you? Well, for homeowners, a drop in the Fed’s rates puts downward pressure on mortgage lending rates, either directly (adjustable-rate mortgages often parallel the Fed rate) or indirectly (giving borrowers an opportunity to refinance at lower rates). Interest rates on HELOCS (Home Equity Lines Of Credit) have also fallen.
Lower payments, more equity
Lower interest rates offer significant benefits to borrowers, such as lower monthly payments or the ability to build equity faster.
But since mortgage interest is tax deductible, lower rates could decrease your deduction and therefore increase your tax bill.
Points to consider
If you have a fixed mortgage, or if your Adjustable Rate Mortgage (ARM) is in its fixed-rate period (many ARMs have a fixed-rate period at the beginning, followed by an adjustable period), you would need to refinance to lock in a lower rate, and that could mean paying loan-originating “points.” These points are themselves deductible, but you have to spread that deduction out over the life of the loan. Do you even remember what you were doing 15 years ago, let alone 30?
Of course, if you stand pat with your current mortgage, that simplifies your life — although it may be a slightly more expensive alternative.
A lot to think about
Most taxpayers take the standard deduction, but for those who itemize, there’s a lot to think about — something to occupy you in between the global pandemic and the presidential election. And when weighing the pluses and minuses of refinancing at a lower rate, it’s important to step back and look at your whole financial picture.
How much would the reduced monthly payment save you each month, over the course of a year, and over the life of the loan? Compare that to the financial hit you could get come tax time. And be sure to weigh any other changes in income or deductions that may come into play. Have you had a new child, or has an adult child moved out? Has your household income changed? Will you donate more or less to charity this year?
Whether you’re refinancing or not — or if you’re considering your first home purchase — it’s important to educate yourself and be aware of all the advantages and costs involved in these decisions.