Home Equity Loan - Tax Deduction Advantage

"Leverage the favorable tax treatment of home equity loans."

A good home equity loan program may provide you with certain tax advantages unavailable with other kinds of loans. Check with your tax adviser for complete details.

Q: Is the amount of interest paid on a home equity loan that qualifies as "tax deductible" limited to $100,000 when refinancing a $500,000 mortgage to take advantage of current low rates?

A: According to IRS Publication 936, "Home Mortgage Interest Deduction," the limits on home mortgage interest deductions depend on several factors in addition to the dollar amount:

• Income bracket
• Primary and secondary home value
• Qualifying deductible interest.

Income bracket

If your adjusted gross income is more than $137,300 ($68,650 if you are married, filing separately) see Schedule A (Form 1040) for deduction limitations based on AGI.

Primary and secondary homes exceed $1 million

If married, filing separately — on homes purchased after Oct. 13, 1987 the limit is $500,000.

Those who meet the above criteria, may qualify for interest deductions on an equity mortgage of $100,000.

• $100,000 ($50,000 if married filing separately), or
• The total of each home's fair market value reduced — but not below zero — by the amount of its home acquisition debt and grandfathered debt.

Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

Check with your tax advisor or accountant.

To ascertain if you qualify and determine your deductions, consult the IRS website.
 

What is the advantage of a home equity loan versus other loan programs?

First it's important to note that consumer debt is no longer deductible on your taxes. If you borrow against your home equity to pay off those debts, then the interest paid to retire the debt is tax deductible.

A home equity loan is better in many cases than refinancing your mortgage because there are no origination fees or points charged to obtain this type of home loan.

For further examples of cost differences, see the E-loan website.
 

What is the most common types of non-deductible consumer debt?

These include car loans, personal loans and credit-card debt. None of these items can be deducted from your taxes. The difference between qualifying as a deduction and not is the type of interest.
 

Home Equity Loan Type of deductible interest

Interest on debt secured by a the mortgage or lien on your personal residence is deductible. Mortgages used for significant home improvement projects or acquiring a second home or securing a vacation home is100% interest deductible up to the first $1 million of such debt.

Note that if you were to borrow more than $1 million for the two residences, the interest above the $1 million does not qualify for deduction.

You are allowed the option to borrow an additional $100,000 with a home equity loan, which translates to a total of $1.1 million in allowable borrowed funds on both homes.

The interest in this scenario is fully deductible.

The Fair Market Value Basis

The deductible interest is limited to your home's fair market value less your current mortgage indebtedness. Most lenders will only lend a maximum of 80% of its value.

So, upon securing the loan with a mortgage on your house, unless the value of your home has decreased, you should have at least 20% equity on which to borrow.

To the extent you have equity, your consumer debt converts to interest deductible home equity debt.

 
Home Equity Loans and Credit Card Debt

One of the most common approaches to debt reduction is taking out a home equity loan to consolidate debt or reduce debt charges and penalty fees.

Home Equity Loan are often used to pay off credit card debt.  To begin the debt reduction process, use the appropriate links in the E-loan loan center.
 

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