 Beware
of limits on home equity deduction
Tax Talk by George
Saenz • Bankrate.com
 Dear
Tax Talk,
I am considering a debt consolidation loan that
would loan me an amount in excess of the equity in my home. The
loan amount would be $25,000 and I currently have a mortgage of
$170,000 with no equity. By establishing this second mortgage, would
I receive a tax deduction for the interest on the second mortgage?
My wife and I make $55,000 together. -- Blake
 Dear
Blake,
Only in this country would someone provide you
a secured loan that is more than the value of the security. What
these folks are banking on is that you have good credit, that the
value of the home will appreciate to eventually cover the loan and
that you're not willing to live on the street. In addition, the
lender will probably charge you a higher interest rate.
Generally, interest paid on a second mortgage is deductible.
But there are a few basic restrictions.
First, the second mortgage cannot exceed $100,000
plus the amount of any substantial improvements made to the home.
For example, if you build a pool for $25,000 you can borrow up to
$125,000 on a mortgage and deduct the full amount of the interest
paid.
Another limitation is that you cannot deduct the home
mortgage interest on home equity debt if you used the proceeds of
the mortgage to buy securities or certificates that produce tax-free
income.
Lastly, the combined mortgages cannot exceed the value
of the home. In your case, as you have no equity, the interest paid
on the debt consolidation loan is not deductible.
In reality, the lender is giving you a personal loan
and is disguising it as home equity indebtedness. As the value of
the home increases over the years, the amount of the second mortgage
debt that qualifies as home equity debt will also increase so that
eventually the debt will produce a deduction.
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