The answer to the question of whether interest on a home equity line of credit is tax deductible is maybe. If you need cash and have equity in your home, a home equity loan or line of credit can be an excellent solution. But the tax aspects of either option are more complicated than they used to be.
There are two types of home equity loans: a fixed-rate loan for a specified amount or a variable-rate line of credit, or HELOC. Depending on your uses and need for the funds, one of these may work better than the other. (See Home Equity Loan vs. HELOC.) Interest paid on either loan, like the interest on your first mortgage, is sometimes tax-deductible.
New Rules for Home Equity Tax Deductions
Since the Dec. 2017 tax law changes, whether interest on any kind of HELOC or home equity loan is tax deductible depends on how you are spending the loan funds. This applies to interest on both loans that existed before the new tax legislation and on new loans. Here's how it works:
Interest on home equity debt is deductible if you use it for renovations to your home – the phrase is "buy, build or substantially improve." What's more, you must spend the money on the property whose equity is the source of the loan. If you meet those conditions, interest is deductible on a loan of up to $750,000 (and up to $375,000 for a married taxpayer filing a separate return). Click here for the IRS statement on this subject.
Note that $750,000 is the total new limit for deductions on all residential debt. If you have a mortgage as well as home equity debt, what you owe on the mortgage will also come under the $750,000 limit – if it's a new mortgage. Older mortgages may be covered under the previous $1 million limit (or $500,000 for a married taxpayer filing a separate return).
This gives people borrowing for renovations more benefits than before. Previously, interest was deductible only on up to $100,000 of home equity debt. However, you got that deduction no matter how you used the loan – to pay off debts or to cover college costs, for example.
On the other hand, interest on home equity money you borrow for non-renovation purposes is no longer tax deductible. This new law applies between 2018 and the end of 2025. Given how complicated this all is, check your particular situation carefully with a tax expert before you deduct anything.
Other Benefits of a HELOC
Home equity loan and HELOC rates are only slightly higher than first mortgage rates, making them much lower than other loan options. And taking a HELOC means you only borrow as much as you need – not a lump sum, as is the case with a home equity loan. Similar to a credit card, the interest rate is variable and applicable to the outstanding balance. Sometimes, a HELOC features an option to lock in a fixed interest rate to repay the outstanding balance.
The homeowner may borrow up to a specified amount based on the combined loan-to-value ratio, which includes the outstanding balance from a first mortgage plus the additional requested funds. Generally, the combined loan-to-value ratio for a HELOC cannot exceed 90%. However, some lenders will write loans for up to 125%. If you are selecting one of these loans, any interest on a balance that exceeds the home's value cannot be tax-deductible. These higher-LTV loans assess higher fees and put you at higher risk of going underwater on your loans should real estate values drop.
Home Equity Loans and HELOCs
The Smartest Way to Tap Your Home Equity
Refinancing Your Home Equity Loan: A How-to Guide
5 Reasons Not to Use Your Home Equity Line of Credit
How a HELOC Fixed-Rate Option Works
Refinancing vs. Home Equity Loan
Choosing a Home Equity Loan or Line of Credit
Home Equity Line of Credit: 4 Ways to Refinance
Bad Credit? You Can Still Get a Home Equity Loan
Mortgage vs. Home Equity Loan: How They Differ
What to Do If You Can't Pay Back a Home Equity Loan