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If you took out a mortgage on your home before October 14, 1987, or you refinanced such a mortgage, it may qualify as grandfathered debt. To qualify, it must have been secured by your qualified home on October 13, 1987, and at all times after that date. How you used the proceeds does not matter.

Grandfathered debt is not limited. All of the interest you paid on grandfathered debt is fully deductible home mortgage interest. However, the amount of your grandfathered debt reduces the $1 million limit for home acquisition debt and the limit based on your home's fair market value for home equity debt.

Refinanced grandfathered debt:

If you refinanced grandfathered debt after October 13, 1987, for an amount that was not more than the mortgage principal left on the debt, then you still treat it as grandfathered debt. To the extent the new debt is more than that mortgage principal, it is treated as home acquisition or home equity debt, and the mortgage is a mixed-use mortgage. The debt must be secured by the qualified home.

You treat grandfathered debt that was refinanced after October 13, 1987, as grandfathered debt only for the term left on the debt that was refinanced. After that, you treat it as home acquisition debt or home equity debt, depending on how you used the proceeds.

Exception - If the debt before refinancing was like a balloon note (the principal on the debt was not amortized over the term of the debt), then you treat the refinanced debt as grandfathered debt for the term of the first refinancing. This term cannot be more than 30 years.

Example:
Chester took out a $200,000 first mortgage on his home in 1986. The mortgage was a five-year balloon note and the entire balance on the note was due in 1991. Chester refinanced the debt in 1991 with a new 20-year mortgage. The refinanced debt is treated as grandfathered debt for its entire term (20 years).

Line-of-credit mortgage:

If you had a line-of-credit mortgage on October 13, 1987, and borrowed additional amounts against it after that date, then the additional amounts are either home acquisition debt or home equity debt depending on how you used the proceeds. The balance on the mortgage before you borrowed the additional amounts is grandfathered debt. The newly borrowed amounts are not grandfathered debt because the funds were borrowed after October 13, 1987.

From IRS Publication 936

All Chapters concerning this topic: home mortgage interest; secured debt; qualified home; Special Situations; Points; Mortgage Insurance Premiums; Form 1098, Mortgage Interest Statement; How To Report; Special Rule for Tenant-Stockholders; Home Acquisition Debt; Home Equity Debt; Grandfathered Debt