Is a Home Equity Loan Tax Deductible in 2018?
A home equity loan allows you to borrow against the value of your home by taking out a second mortgage.
January 1st, 2018, the tax deduction on a home equity loan will be changed. This change will affect both new and existing home equity loans.
An equity loan is a second mortgage used to borrow against the equity in your home. When the second mortgage was used to purchase your home, the mortgage interest is still tax deductible in 2018.
A home equity loan taken for any reason other than the purchase of the home is NOT deductible for the 2018 tax year.
Under the new tax law, you may write off eligible mortgage interest on home loans up to $750,000. This limit includes both your first mortgage, as well as any other mortgages on the home.
Home Equity Growth
Home values across the Country have been rising since 2012. The equity earned by homeowners continues to build as the economy grows.
Every month you make your mortgage payment you are also paying down your loan. Paying down your mortgage also increases the equity in your home.
The reasons you would want to withdraw this money from your home vary widely depending on your situation.
The most common reasons for using a home equity loan
- Cash out for home improvements
- Debt consolidation to pay off high interest debt
- Paying college tuition
Unfortunately, your mortgage interest would not be tax deductible if used for any of these reasons.
How a HELOC Works
A HELOC is the most common form of home equity loan. HELOC is short for Home Equity Line of Credit.
A HELOC is usually a 15 to 20 year adjustable rate mortgage tied to the Prime Rate. The current Prime Rate in the United States is 4.5%.
When you hear news about the Federal Reserve increasing rates, it directly impacts the Prime Rate. Currently, the Federal Reserve has 3 more increases scheduled for 2018.
Each increase in the past has been .25%, which would make the interest rate on a HELOC around 5.25% by the end of 2018.
Despite the variable interest rate feature of these loans, you are only required to make an interest only payment for the first 1o years of the loan.
Once the interest only period is up, the loan will fully amortize over the remaining term of the loan. For instance, if you have a 20 year term, the loan will require full principal and interest payments for the remaining 10 years.
The benefits of a HELOC include option of making an interest only payment if you would like. Another benefit is that you do not have to borrow the full limit of the equity line at once.
Once you pay down the balance of your HELOC, you can then borrow that money again, similar to using an ATM card to access money when you need it.
The down side to using a HELOC, in addition to not being tax deductible, is variable interest rate.
Home Equity Loan Loophole
Home owners can still get access to the equity in your home, AND it can be tax deductible.
A cash out refinance allows you to borrow against the equity in your home and allows you to write off the mortgage interest up to a maximum loan amount of $750,000.
Interest rates remain historically low on home loans, and are slowly rising. The lowest interest rates in the past 12 months was September of 2017. Since then, home loan interest rates are slowly and steadily increasing.
Since then, home loan interest rates are slowly and steadily increasing.
I expect that interest rates will continue to rise slowly throughout the year, experiencing the minor ups and downs as is common in this market.
Cash Out Refinance vs HELOC
Comparing apples to apples, a cash out refinance is likely to carry a lower over all interest rate cost at the end of the day.
One downside of a cash out refinance is that it’s a one time refinance, and you cannot continue to borrow from it after you’ve secured the loan.
While the HELOC does offer more options, a cash out refinance will provide the security of a fixed payment.
Additional Reading: Cash-Out Refinance vs. Home Equity Loan – Which Is Better?
Explore Your Options
If you’re unsure about what option will benefit you most, it’s important that you consult a professional loan officer that does this for a living.
A mortgage expert will also encourage you to discuss your options with a CPA or tax preparer to explore the impact on your tax liability.
The new tax law almost doubles the standard deduction for all tax payers. The result will be that many homeowners will no longer benefit from taking a mortgage interest deduction if your standard deduction saves you more money.
This now becomes a opportunity to consider which home equity loan option best fits your needs, and the tax implications will be irrelevant.
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