Be Careful of the amount of interest you deduct on your federal taxes. The IRS is scrutinizing homeowners who have been taking illegal tax write-offs.
Only the interest on the mortgage amount that equals your home's fair market value at the time of the loan is deductible.
Don't be mislead by a lender trying to sell you a low- or no-equity mortgage. All interest paid on the loan amount above the fair market value of your home, cannot be deducted on your income tax.
If you report it to the IRS, you might get caught. The IRS is targeting homeowners with 125% mortgages to see if those loans were initiated to help pay off consumer debt instead of for home improvements.
What's Happening
The IRS is trying to tag home owners who have mortgages that exceed their home values. The information your lender sends to the IRS enables tax auditors to cross-check the interest deductions. If your Form 1098 says the mortgage interest you paid during the year was $3,500 - and your tax return claims $5,000 - the IRS can detect cheating on taxes.
How It Should Work
A home owner with a $150,000 loan on a $170,000 home who also has $40,000 in non-deductible auto and credit card debt might apply for and receive a high loan-to-value second mortgage of $30,000 - $40,000.
The interest on the second mortgage is only partially deductible. Only the interest on $20,000 of the amount borrowed may be deducted. The balance of the interest is not deductible because it exceeds the value of the property.
Another Pitfall of 125% Mortgages
Are you thinking of selling your house in the next few years?
If you have a mortgage that is higher than the market value of your property, you will have to go to closing with cash in order to complete the sale. If it's a significant amount of cash, you may not be able to sell your house at all.
Consider this: Your home is worth $150,000 but you have a 125% mortgage that amounts to $187,500. You get an offer of $148,000 which you'd like to accept. However, once you deduct from the grosse price real estate commissions, closing costs, and any other associated costs of selling, you end up ten or fifteen thousand dollars in the red. Add that ten or fifteen thousand dollars to the difference between the mortgage and the selling price, and you'd have to bring $50,000 or more in cash to closing!
