Is Home Equity Loan Interest Tax-Deductible?
Many homeowners use home equity loans for home remodeling projects, to pay for weddings, to pay medical bills, or something else. These loans usually have interest rates that are lower than other financing options, which makes them an affordable way to borrow money.
If you are thinking about taking out a home equity loan, you may be wondering whether you can deduct the loan interest on your taxes. In short, it depends on what you use the money you borrow for.
Before you apply for a home equity loan, it’s important to keep in mind that the tax rules change each year. Something that is tax-deductible one year may not be the next. Because of this, it’s important to consult with a tax professional before taking any deductions.
How Do Home Equity Loans Work?
Home equity loans are very similar to personal loans in how they work. The primary difference is in the collateral requirement. While personal loans usually don’t require collateral, home equity loans are backed by the equity in your home. This is the reason why they often have interest rates that are lower than other borrowing options.
If you are approved for a home equity loan, you will receive a lump sum for the full amount upfront. You will then repay it with fixed monthly payments. There are usually few or no restrictions on what you can do with the money you borrow.
The interest rates for home equity loans are fixed. The rate is locked in when the loan is created, so you won’t have to worry about any future rate increases.
It’s important to keep in mind that if you sell your home before you have repaid your home equity loan, you will be required to repay the remaining balance in full. This is because the loan is no longer backed with collateral. The proceeds from the sale of the home can be used for loan repayment.
How Do HELOCs Work?
Home equity lines of credit (HELOCs) are another popular way that homeowners borrow money. Like home equity loans, HELOCs also use the equity in your home as collateral. There are important differences, however, in how the two loans work.
An important difference with a HELOC is how you receive the money. Instead of receiving a lump sum for the full amount, with a HELOC, you are given a line of credit that you can draw from as needed. Your credit limit is replenished when you repay the money you borrowed. You can repeat the process of borrowing and repaying money as often as you like during the draw period.
An important feature of HELOCs that many borrowers like is that you can make interest-only payments on the money you borrow during the draw period. If you have an unpaid balance when the draw period ends, however, a balloon payment may be required where you will have to repay the full amount. Depending on your lender, you may be able to refinance the balance into a conventional loan and repay it with fixed monthly payments.
Unlike home equity loans, HELOCs have variable interest rates. This is because you can draw money at any time during the draw period, which may be as long as 10 years. The interest rate must be variable to reflect the current rate whenever money is borrowed.
Is Home Equity Loan Interest Tax-Deductible?
Whether you are borrowing with a home equity loan or a HELOC, the loan interest is tax-deductible as long as certain requirements are met.
Interest on home equity loans used to be fully tax-deductible, regardless of what the borrowed money was used for. This changed, however, with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. Now, home equity loan interest is only tax-deductible if the money is used to purchase a home, build a home, or perform major renovations to an existing home.
It’s important to point out that cosmetic improvements do not constitute major renovations. The IRS states that you have to make “substantial renovations” to qualify.
The amount of interest you can deduct on your taxes is significant, and most people will not have to worry about exceeding the limits. Under the new guidelines, you can deduct up to $375,000 if you are an individual filer. Married couples filing jointly can deduct up to $750,000.
An important consideration with deducting home equity loan interest is that it may make sense in some cases to go with the standard deduction instead of itemizing. The standard deductions for both single and married returns have increased substantially in recent years. It is now $12,000 for single filers, $24,000 for married couples filing jointly, and $18,000 for heads of household.
Documents for Deducting Home Equity Loan Interest
If you do decide to take the home equity loan interest tax deduction, it’s important to keep all records pertaining to your loan and what you purchased. This will be helpful if you get audited.
You will need to keep a copy of your loan application, the closing disclosure, and form 1098, which is a mortgage interest statement. Your lender will provide you with these documents.
Finally, it's important to save all documentation for your home renovation project. You will want to retain invoices, receipts, work orders, and other information that proves the money you borrowed was used to renovate your home and was not used for something else.
Home Equity Loans with Members Heritage Credit Union
If you need to tap into your home's equity for a home renovation, to consolidate debt, or for something else, Members Heritage Credit Union offers a home equity loan with a competitive interest rate and flexible payment terms that may be up to 15 years.
With our home equity loan, you can borrow anywhere from $10,000 to $250,000 without an appraisal. There are also no annual fees or prepayment penalties.
Click below to learn more about our home equity loans.
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