Whenever there is a drop in the mortgage interest, million of people flock to the lenders to refinance their mortgage. However, before you can take this step, it is important to familiarize yourself with the tax rules on what is or isn’t deductible for the payment of interest.

Whether you are entitled to deduct interest on the amount that is excess depends on how you use the proceeds from the mortgage refinancing. When you use this amount to build, buy or improve your principal residence, your interest payment is put under the rules for homes acquisition loans. The rules allow you to deduct the whole interest as long as the excess together with all your home acquisition loans doesn’t exceed $1million. This amounts drops to $ 500,000 for married couples who file separate returns.

When you use the excess for any other purpose, there are rules that prohibits making the deductions for interest payment on the ”consumer loans”. The wide-ranging category includes auto loans, credit cards, medical expenses as well as other personal debts.

But you can sidestep the restrictions on the deductions for consumer interest, when you take advantage of the rules on home equity loans. The rules allow you to deduct the whole mortgage interest if the amount in excess of your current mortgage together with your other home equity loans doesn’t exceed $100,000. This drops to $50,000 for married couples who file separate returns. It doesn’t matter how you use the proceeds.

When your refinanced loans are partly home acquisitions loans and partly loans for home equity, the overall limit is $ 1,100,000 consisting of $1,000,000 debt on home acquisition and a $ 100,000 home equity debt. The amount drops to $550,000 for married couples who file separate returns. If the loans exceed the ceilings for both the home acquisition loans and the home equity loans, any excess is considered as a nondeductible personal interest.