If you refinanced your mortgage this year, congratulations. But donít forget that the lower rate comes with a smaller mortgage interest deduction. And that means a higher tax bill.

In 2000, an estimated 34.9 million tax returns claimed $295.7 billion in mortgage interest deductions. This year, a record 7.8 million households are expected to refinance their mortgages.

Hereís the good news: all that refinancing will save some $10 billion in interest payments in 2003, says economist Douglas Duncan of the Mortgage Bankers Association, and free up roughly $8.3 billion for us to spend. Refinancings have been a huge reason that consumer spending has been so strong in the last few years.

But thereís a catch: Those of us who refinanced will also pay close to $1.7 billion in additional federal income taxes.

The tax hit wonít affect everyone. It only affects you if you itemize your deductions. Youíre going to pay a price for refinancing.

If You Donít Itemize

If you donít itemize, the rest of this just doesnít apply to you. Put a big smile on your standard deduction face.

Youíve now locked in the lowest interest rates in 50 years, and the difference between the rates is stuffing your pockets with dollars that would have gone to your mortgage company. Alternatively, you could pay the same amount of dollars out of pocket and pay off your home in fewer years.

In any case, youíre the big winner!

If You Do Itemize

This is what happens when you itemize: If you pay less, you deduct less. If you refinanced a $100,000 loan from 9% to 6%, thatís a 3 percentage point difference, or roughly $3,000 that you donít get to deduct.

The earlier in the year you refinanced, the more of that $3,000 you're going to lose. Over the 12 months of , youíre going to lose the whole difference.

(I know that the principal is reduced with each payment, so my numbers are off ó Iím simplifying to make a point here.)

But youíre still way ahead, no matter how much you lose. With a top federal tax bracket of 35%, a loss of $3,000 in interest deductions costs you $1,050. But you didnít pay $3,000. So youíre still $1,950 ahead.

And clearly you put aside at least enough cash out of the $3,000 saved to pay the additional tax ó right?

Do You Really Need to Itemize?

The reduction in your interest deduction may have other consequences you should think about before the end of the year.

For most of us, you itemize only if your itemized deductions exceed your standard deduction.

The reduced deduction may put you below these numbers. In that case, you should take the standard deduction instead.

But What About the Points?

There may be some sunshine behind the cloud. Unlike when you bought your house, when you refinance, any points you pay normally are amortized over the life of the loan. This is done on a monthly basis.

So, say you refinanced a $100,000 loan for 20 years at a cost of three points, or 3%. That $3,000 would be divided by the loan term, 240 months, for a $12.50-per-month deduction. If you took out the loan on July 1, youíd have 6 months of amortization, or a deduction of $75. Next year youíd take a full yearís deduction of $150.

The bad news: You canít just deduct all the points.

The good news: Thereís an exception. Letís say you refinanced your mortgage for more than your original loan and used the difference to improve your home. Then the percentage of points paid representing the dollars used for the improvement can be deducted in the first year.

So, say your home has substantially appreciated, and you were able to borrow $300,000 to refinance a $200,000 loan. You put $100,000 into improvements to your property. If you paid $3,000 in points (1%), one third ($100,000/$300,000), or $1,000, would be an allowable deduction.

Youíd also get to deduct the additional $2,000 paid, over the term of the loan. Over 240 months, that would give you an additional deduction of $8.33 per month.

The Break From Multiple Refinancings

Hereís some more good news. If this isnít your first refinancing, youíll probably have what the tax pros call ďunamortized points.Ē Those are the points that you paid on your first refinancing that havenít been allowed yet.

Those points are allowed in full this year.

So, letís say you refinanced July 1, , and again July 1, . On the first refinance, you paid $3,000 in points on a 30-year note. Last year, you deducted six monthsí worth of amortization, or $50 (That's $3,000 divided by 360 months, multiplied by six months).

This year you get to deduct the remaining $2,950 in full.

What else can you do to make up this yearís loss?

Make your January 1, mortgage payment on December 31, . The payment is for the use of the money in December, and will be allowed.

Your mortgage company wonít receive it until , so the interest wonít be shown on their Form 1098. Remember to run an amortization schedule and place the additional interest payment on Schedule A on the line for ďinterest paid but not reported to you on Form 1098.Ē You can use the Financial Calculator to produce the amortization schedule, and even to print it.

Run your own numbers. Make sure that you meet the safe harbors for withholdings and estimated payments.

As George Leupold, of Leupold Financial Planning Associates of Cherry Hill, N.J. succinctly put it, ďDon't let the tax tail wag the financial planning dog.Ē

Bottom line: Unless youíre in a tax bracket thatís over 100%, a reduction in interest rates is going to save you real cash money ó even after the tax loss. So donít worry about the taxes. Just plan for them.