One potentially costly tax issue that many people don’t consider when refinancing their mortgage

With interest still sitting near historic lows (some 15-year refi rates are near 2% and some 30-year rates are below 3%), refinancing to lock in a lower rate and/or shorten the time period of a mortgage can be a smart financial decision. But, “the tax implications can create financial consequences for years to come, and it’s essential that each homeowner be informed how a transaction will impact them,” says Bobbi Rebell, a certified financial planner and personal finance expert at Tally. But you can be tax-smart about your refi. Here’s how. 

1. A big drop in your interest rate could impact your tax-deductible interest

One possible tax impact people often don’t consider is that a large drop in your interest rate could also result in a large drop in tax-deductible interest, says Denny Ceizyk, senior staff writer at LendingTree: “This could leave you with a higher federal tax bill come tax season,” says Ceizyk. 

2. You may be able to deduct points

You may be able to deduct points from your taxes (you buy points in order to get a lower interest rate), though these are typically deducted over the duration of the loan, so you’d deduct a portion of them each year. 

3. The new(ish) mortgage interest deduction rules may impact you

The mortgage interest deduction — a tax incentive for homeowners — used to allow homeowners who itemize to deduct mortgage interest paid on $1 million worth of principal per couple, but now it is on just $750,000. The good news for those with pricier homes: If you got a mortgage on your home before December 15, 2017, when the new rule went into effect, you are grandfathered into the old $1 million rule.

But this all means you have to be very careful with refinancing. In order to maintain that $1 million dollar limit, you cannot increase the current size of the loan and you cannot increase the final due date of the loan. For example, if you are 10 years into a 30 year loan, you can’t go beyond 20 more years. You cannot even take money out to cover the closing costs, so homeowners need to budget for that, says Rebell. 

4. Don’t freak out about your property tax bill, yet

“Your refinance appraisal doesn’t make it into the hands of your local tax assessor, so it won’t have any direct impact on your property taxes. However, if prices are skyrocketing in your area, a jump in your property tax bill may be in your future,” says Ceizyk.

5. Think about these things if you do a cash-out refinance

The cash you get out from a cash-out refinance is not considered income by the IRS, which means you don’t pay income taxes on it.  But here’s where it gets tricky: For the most part, Ceizyk explains, the current tax laws don’t allow you to deduct interest when you tap equity unless it’s being used for home improvement. “If you do use mortgage refinance funds to spruce up your home, make sure you keep receipts and contractor bids to document the work that was done,” says Ceizyk.

Still, Grace Yung, a financial planner and managing director at Midtown Financial Group, says it may still make sense to do a cash-out refinance to pay off credit card debt, even if you can’t deduct interest. “At the end of the day, even if one cannot write the interest off on funds used for purposes other than home improvement, the money saved by paying off higher interest debt such as credit cards may yield an overall net gain,” says Yung. 

Bottom line: When doing a refi, you may want to consult a tax advisor, because each situation is unique, says Yung.