Sometimes the idea of taking out a second mortgage 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.
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 and is 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 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 passage of the Tax Cuts and Jobs Act of 2017, you may no longer deduct the interest of the loan if it was used for any other 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 itemize your deductions and would like to deduct home equity loan interest paid, you will need to supply your tax preparer with IRS Form 1098, Mortgage Interest Statement. Tax planning can be incredibly stressful and intimidating, especially when taking new actions such as deducting loan interest. It is always best to check with a trusted tax professional to ensure you remain compliant with the most updated tax laws. If you need tax help, give us a call at 800-536-0734 for a free consultation with one of our knowledgeable tax professionals.