When you are in need of a large lump sum of cash to purchase a car, do some remodeling on your home, or pay for your child’s college tuition, generally people head straight to the bank and take out a line of credit, apply for a personal, or simply put the charge on the credit card. Most of us don’t even think about taking out a home equity loan.
Just mentioning those words can seem scary…. borrow against my house??? It sounds shady. But I am here to give you a little more insight on the subject and maybe shed a little light on the scary subject.
According to an article on Realtor.com, the cost for obtaining $10,000 for one year is $1,800 for a credit card, $1,000 for the sale of stock, $900 to tap a (401)k plan or take out a personal loan and only $576 for a home equity loan. The costs are based on a set of conventional assumptions about the interest rate and costs typical for each type of loan.
Who knew that this “scary” loan can actually have the most attractive interest rates? Not to mention, the amount borrowed could potentially be tax deductible! Ok, there are some loopholes here but I’ll lay them out for you below.
We’ve all seen those ads for HELOC or home equity line of credit ads that state tax deductible up to $100,000. This is a bit misleading and possibly a reason why most of us brush the option off as unlikely. The actual law states that if the interest portion of the debt exceeds the home’s total value,even if it is below $100,000, it is not tax deductible.
Still confused? Let’s use an example from an article on Bankrate.com. Let’s say that you bought your home for $95,000 and it is currently valued at $110,000. The bank offers you a 125% loan to value equity loan. That would be ($110,000 x 125% = $137,500) now you have to subtract the amount that you still owe on your mortgage ($137,500-$95,000 = $42,500) The bank will offer you a $42,500 HELOC on your home. This amount is obviously below $100,000, however, that loophole that we were talking about states that the tax deductible amount cannot exceed the total fair market value of your home. ($110,000-$95,000 = $15,000) This means that only the first $15,000 of your HELOC can be considered tax deductible while the other ($42,500-$15,000 = $27,500) $27,500 is not tax deductible.
There is one case, however, that is completely different: when you are using the money for home renovations/improvements. The IRS views this as a completely different tax treatment since it is adding value to the current value of your home. In these cases you are allowed to deduct interest on up to $1 million in mortgage debt. You will have to have proof of this though in case you are audited (don’t get caught with your pants around your ankles on this one – if the IRS finds that you have incorrectly deducted the interest from your HELOC over $100,000 or above your home’s value and it was not for home improvements, you will be fined for all of those back interest taxes + interest + fees!)
While this is an attractive option to some people, just make sure that the loan fits your needs. Remember, it is not free money. You are borrowing money using your house as collateral so if by the end of the loan term, you cannot repay your debt, you could be forced to move!
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Home Run Real Estate Team