Under the current tax system, there are two different kinds of debt. Money you borrow to buy, build or substantially improve your residence is called "acquisition indebtedness." Money  borrowed  against the equity in your home, or money borrowed  when you refinance your home for any reason except home improvement, is called "equity indebtedness."

On loans made on or after October 14, 1987, you can deduct mortgage interest paid on acquisition indebtedness up to a total of one  million dollars. This means you could buy a home for $250,000, another home for $200,000, and add a family room to your first house for another $150,000, and still have $400,000 to spend on these homes for further improvements before you reached your limit for interest deductibility. The one million dollars is not cumulative. As you pay off a loan, you would add that amount to your total purchasing or improving up to two residences.

Your equity indebtedness limit is $100,000. That means that you can borrow up to $100,000 of the equity in your home and use it for whatever you want. This is a change from the pre-1986 tax rule that limited your equity borrowing beyond the purchase price to certain qualified expenses, like home improvements, medical and education expenses.

The drop in interest rats has meant that  many homeowners have refinanced their mortgage at a lower interest rate. In the past, refinancing your mortgage has proved to be an excellent opportunity  to lower your interest rate and monthly payment and also to take equity out of your home.

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When refinancing your mortgage, you will probably pay up to  6 percent of the loan amount in closing costs-for surveys, legal fees and paperwork fees. Many of these closing costs are deductible, but not necessarily in the year that you refinance. I f you are considering refinancing your mortgage under the current tax rules, however, there are a couple of things to bear in mind. If you refinanced before October 14,1987, for a longer term than was remaining on the pre-October 14 loan, you may only de duct the interest paid on the mortgage for the term that was remaining on the old loan. So if you refinanced a loan with 15 years remaining for a 30-year loan with lower payments, you can only deduct the mortgage interest paid on the new loan for 15 year s. The one exception is if you had a balloon mortgage payment come due and you refinanced it to a loan of not more than 30 years; you get the deductibility for the full term of the longer loan. Any refinanced debt you incurred before October 14,1987, is rolled into your total acquisition indebtedness.

In the past many homeowners have refinanced mortgages on their appreciating properties to draw on their equity to buy a new car or take a vacation. Under the new tax system, homeowners will no longer have unlimited mortgage interest deductions when drawing on equity. Any equity debt incurred is subject to a limit of the amount of on equity. Any equity debt incurred is subject to a limit of the amount of the existing debt plus $100,000. Say, for instance, that you bought your house 10 years ago and have seen the property grow in value from $70,000 to $230,000. If you refinance your mortgage (on which you now owe $50,000), you may only deduct the interest paid on the total of your acquisition indebtedness in the property ($50,000) plus $100,000. You will be able to deduct the interest paid on $150,000.