Sometimes the idea of taking out a second mortgage is a necessity. It can be a viable solution to eliminating debt, funding home renovations, or paying off unexpected medical bills. Before taking out a home equity loan, you should know the tax implications that come with it. Here’s how home equity loans affect taxes.
What is a home equity loan?
Also known as a second mortgage, a home equity loan is a type of consumer debt that allows homeowners to borrow against the equity in their residence. The equity that you have accumulated through mortgage payments is used as collateral. The loan is paid out to you in a lump sum. Then it’s repaid with interest at a fixed rate each month for a set number of years.
How much can I borrow with a home equity loan?
Typically, the max you may borrow is around 80% to 85% of your home’s appraised value less the remaining balance on your mortgage. For example, let’s say your home is valued at $500,000, your mortgage balance is $200,000, and your lender will allow you to borrow up to 80% of your home’s value.
$500,000 x 80% = $400,000
$400,000 – $200,000 = $200,000 maximum loan amount
In this scenario, you may borrow up to $200,000. The principal would be repaid at a fixed rate each month for a set number of years. This is in addition to your regular mortgage payment, hence the term “second mortgage.”
How Do Home Equity Loans Affect My Taxes?
Like many other loans, the interest on a home equity loan can be tax deductible, but there are some limitations. If you used funds from the loan to “buy, build, or substantially improve” the home that was used to secure the loan, the interest is tax deductible. Since the Tax Cuts and Jobs Act, you can’t deduct loan interest if it was used for another purpose. The amount of interest that may be deducted will also depend on your filing status.
Tax Relief for Homeowners
Deducting home equity loan interest only makes sense if your itemized deductible expenses are more than the amount of the standard deduction. If you choose to deduct home equity loan interest, you‘ll need to use IRS Form 1098, Mortgage Interest Statement. Tax planning can be incredibly stressful and intimidating, especially when taking new actions such as deducting loan interest. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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