Many retired Senior Military Officers and NCOs use a VA loan to purchase their house after retirement. That loan will have a funding fee if you don't have a disability rating. The good news is that under certain circumstances if you filed for a disability rating before applying for the loan, you can get a refund of the funding fee (read more about the funding fee and refunds here). You can include the funding fee in your loan and if you get a refund you don't have to use the refund to pay down your loan. But does the refund affect your taxes?
Not All Mortgage Interest is the Same
Interest on loans used to purchase or improve a home is called home acquisition debt and the interest on it is tax deductible. Interest on home equity debt, which is interest on a loan where your house is the collateral and the proceeds aren't used for purchase or improvements, is not deductible. Therein lies the rub.
When you purchased the home, adding the funding fee to your loan balance was considered home acquisition debt. But now if you get that money back and you don't use it to pay down the loan is the amount of the VA funding fee now home equity debt? I'm not 100% sure, but I think it probably would be.
That means the interest on the amount of the funding fee would no longer be tax deductible. You would need to prorate the interest into tax deductible and non-tax deductible portions. The good news is, you won't have to do this every year. The tax law allows you to count principal paid against your home equity debt first. So, once you've paid off an amount of principal equal to the VA funding fee, all your interest will be deductible.
Military Finances Aren't Like Civilian Finances
Non-VA loans don't have this funding fee and someone not familiar with military finances and taxes is unlikely to know that the funding fee even exists. You might want to work with someone who lives and breathes military finances each and every day. We know this stuff is a little geeky, but you want to get your taxes right. That's why we're always researching and thinking about how unique military and veteran benefits affect your financial plan.
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