Taxes and your home equity loan
house is much more than just a shelter. For many homeowners, it serves as a private
When structured properly, the money you can
draw from the equity in your home can provide a nice tax break. In most cases,
a homeowner can deduct interest paid on a home equity loan or home equity line
of credit (HELOC) of up to $100,000.
The key phrase, however,
is "in most cases." There are some deductibility limits. The alternative
minimum tax also might also negate the benefits. So before tapping into the residential
vault, homeowners should carefully evaluate their overall financial needs and
Many uses, one big tax
Home equity funds are often used to pay for home improvements,
remodeling and renovations, college costs or consolidate personal loans and credit
card debt. By leveraging the money already put into a house, an owner typically
has access to larger sums of money to pay for these items.
of course, there is the tax advantage.
"When you talk
about taxation and home equity, you primarily look at the deductibility of the
interest," says Jim Hiles, a certified financial planner with CBIZ Wealth
Management in New York. The tax law allows a borrower to deduct interest on a
home equity loan or a combination of loans up to $100,000, regardless of how the
money is used.
"It certainly is a popular way to pay,"
says Hiles, "if you can deduct the interest."
that "if" that trips up some home equity borrowers. Whether it can be
deducted and exactly how much interest on a home equity loan is deductible depends
on several factors.
Interest on $100,000
Most homeowners focus on the $100,000 amount that's usually
touted as "deductible" in ads for home equity products. But borrowers
also need to be aware of how their property's fair market value and any existing
mortgage could affect the tax break.
When the combination of
all loans secured by a home, including the first mortgage and any other equity
loans, are more than the property's fair market value, the interest on the portion
of debt that exceeds the home's value is not deductible.
example, you have a $95,000 mortgage on your home, which is now worth $110,000.
Your bank says you qualify for a 125 percent loan-to-value equity loan of $42,500
($110,000 x 125 percent = $137,500 minus $95,000 left on your first mortgage =
$42,500). Because your son has outstanding college tuition bills and you'd also
like to buy him a car to get to and from school, you take the bank up on the offer,
planning to deduct the interest on the equity loan on your taxes. It is, after
all, well below the $100,000 limit.