Deductions & credits

You must manually calculate and then correct the "Average Monthly Balance" for each loan.  The Average Monthly Balance must be weighted based on the length of time the loan existed for the current Tax year.  The IRS allows different ways of determining the Average Monthly Balance because it is not correct to say your average annual balance is the sum of loans that existed for the entire year.  Your taxes are annual, so in this case, the loan balances must be normalized for the year. And the 2020 tax year was 366 days (12 months).

All of this info is from IRS Publication 936 (This is a 2019 form but it is current for this year.)

https://www.irs.gov/publications/p936

If you want to know how to do this, it is spelled out here:

https://www.irs.gov/publications/p936#en_US_2019_publink

(After publink type the numbers (no spaces), One Zero Zero Zero Two Three Zero Zero Two Eight)

(You think being a tax site, that they would write the posting software to understand IRS URLs and not presume the numbers to be a phone number.)

This section is titled: "Average Mortgage Balance"

There you will see that there are different ways of calculating the average mortgage balance.  You read through the Publication to determine which method that is best for you.

The first method is:

Average of first and last balance method. - This is the method that TT is using, however this only works if you only had one home loan for the year.  As you see the second bullet point for using this method states,

"You didn't prepay more than 1 month's principal during the year. (This includes prepayment by refinancing your home or by applying proceeds from its sale.)"- You see that comment in parenthesis is very critical.  If you refinanced, you did prepay. 

Please also be aware of the other bullet points because as it says, "You can use this method if all the following apply."

What this means is that you did prepay and therefore you have not met a required condition to use this method. You can only use this formula in very specific terms where you didn't change the loan during the year, because it is the most simple way of determining an average.  

The second method is: 

Interest paid divided by interest rate method.

The third method is what we will use for those of us that re-fide or HELOC-ed:

Statements provided by your lender

 https://www.irs.gov/publications/p936#en_US_2019_publink# 

"If you receive monthly statements showing the closing balance or the average balance for the month, you can use either to figure your average balance for the year. You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home. 

For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year. 

If your lender can give you your average balance for the year, you can use that amount."

This method is where I have repeated since last year to use.  I didn't pull it out of thin air either.  You can read it for yourself and I directly copied and pasted it.

Please continue to read past this point in the Publication because it goes on to give direct examples for what I have said.

Mixed-use mortgages.

https://www.irs.gov/publications/p936#en_US_2019_publink# 

This section further elaborates, "For example, a mortgage you took out during the year is a mixed-use mortgage if you used its proceeds partly to refinance a mortgage that you took out in an earlier year to buy your home (home acquisition debt) and partly to buy a car (home equity debt)."

If you want to be really precise, you can average at a higher resolution and weight the balances by the number of days during the year the loan existed.  Unless you are right at the cutoff limit, it probably isn't worth doing this.  And the IRS Pub doesn't give any examples broken down by day, so I am not sure on the acceptance of it. But I like it better as it is mathematically more proper since our loans are as precise as a day.

Also, if you have two loans at the same time, you need to sum those balances before averaging but only for the time they existed at the same time.