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The Tax Cuts and Jobs Act of 2017 introduced new guidelines that reduced the number of instances in which homeowners can deduct the interest they pay on home equity loans and home equity lines of credit (HELOCs).
Through December 2026, this act will allow you to deduct interest on these types of loans as long as you use the money to “build, buy, or substantially improve” the home that secures the loan.
Tax deductions lower your taxable income for the year. Claiming a deduction for home equity loan interest could help to reduce your tax liability or increase the size of your refund.
In this guide:
- In what situations are home equity loans deductible?
- Are there tax differences between a home equity loan and line of credit?
- How have tax law changes affected these tax deductions?
- How do you claim the tax deduction?
- Is it worth using a home equity loan if it isn’t tax-deductible?
In what situations are home equity loans deductible?
Homeowners can now deduct interest paid to home equity loans and HELOCs if they use the money to buy, build, or substantially improve a home secured by the loan.
The IRS doesn’t go into detail regarding “substantial improvement.” But generally, it means anything that adds significant value to the home or increases its usefulness.
See the table below for guidance on whether several expenses qualify for a tax deduction:
|Yes, if used to…||No, if used to…|
|Build or buy a home that’s secured by the loan|
Replace the roof on your home
Upgrade your HVAC system
Install a whole-house generator or solar panels
Build an addition
Remodel your kitchen or bathroom
|Consolidate credit cards or other debts|
Pay education expenses for yourself or your children
Cover medical or veterinary bills
Pay day-to-day living expenses
Fund investments or business expenses
Pay funeral or burial expenses for a loved one who has passed away
Are there tax differences between a home equity loan and line of credit?
A home equity loan and a home equity line of credit both allow homeowners to tap into equity. Your equity is your home value today minus the amount you owe on your mortgage.
A home equity loan and a HELOC give you access to cash from your equity, but they do so differently.
Here are the key differences between a home equity loan and a HELOC:
|Home equity loan||HELOC|
|Interest rates||Fixed rates are typical.||Variable rates are more common, but lenders may also offer fixed rates.|
|Distribution of funds||Paid in a lump sum, which borrowers can use to fund various expenses.||Gives access to a revolving credit line, which borrowers can draw against as needed, similar to a credit card.|
|Repayment terms||Monthly repayment begins once the loan is funded.|
Loan term can extend from 5 to 30 years.
|Borrowers may make interest-only payments during an initial draw period (typically 10 years), followed by principal plus interest payments during the repayment period (as long as 20 years).|
Both a home equity loan and a HELOC represent a type of second mortgage when a primary mortgage is in place on the home. However, it’s possible to have a first-lien home equity loan or HELOC if you use the loan to pay off a primary mortgage.
The Tax Cuts and Jobs Act’s interest deduction applies to home equity loans and HELOCs. As long as you use the funds for an eligible purpose, you can deduct the interest, regardless of whether you have a home equity loan or a HELOC.
How have tax law changes affected these tax deductions?
Before the Tax Cuts and Jobs Act passed, homeowners could deduct up to $100,000 in interest paid for home equity loans and HELOCs for any reason.
In 2018, the scope of the deduction narrowed to cover only the situations above. Unless Congress extends them, these changes will remain in effect through December 2026.
Updating the tax code didn’t just change which expenses qualify for the home equity loan interest deduction; it also altered the deduction amount:
|Married, filing separately||All others|
|Before Tax Cut and Jobs Act||$500,000||$1 million|
Those limits apply across all outstanding loans associated with a single property. So you can deduct the interest on your first mortgage and the interest on your home equity loan up to the limits above based on your tax filing status.
The debt owed on the properties cannot be greater than the value of the properties.
How do you claim the tax deduction?
To claim a deduction for the interest you paid on a home equity loan or HELOC, the first step is determining whether you’re eligible. Be sure you used the funds from the home equity loan or HELOC to build, buy, or substantially improve the home that serves as collateral.
Next, you’ll need to figure out how much interest you’ve paid on the home equity loan. To do that, you can:
- Review your most recent loan statement.
- Call your loan servicer.
- Check your Form 1098 Mortgage Interest Statement. (Lenders send these out at the beginning of the year.)
Then you can start organizing the paperwork you’ll need to claim the deduction on your taxes. That includes your Form 1098 Mortgage Interest Statement from the lender, documentation of how you used the loan funds, and any additional interest expense you incurred.
The IRS requires you to itemize mortgage interest deductions on Schedule A of Form 1040. Understanding the difference is essential if you’re used to claiming the standard deduction.
The standard deduction allows you to deduct a set amount from your annual income based on your filing status:
|Single||Married, filing jointly|
|Standard deduction (2022)||$12,950||$25,900|
When you itemize, you list your separate deductible expenses and deduct the appropriate amount.
If your expenses exceed the limits in the table above—for instance, if you’re married and filing jointly, and your expenses total $33,500—you’ll benefit from itemizing your deductions. You should claim the standard deduction if your expenses are below or equal to the limits.
If you’re unsure, a tax professional can help you figure out the best way to handle home equity loan interest deductions.
Is it worth using a home equity loan if it isn’t tax-deductible?
A tax break in the form of an interest deduction is a terrific incentive to consider a home equity loan. But a home loan can be valuable even if the interest is not deductible.
For example, you might consider a home equity loan if you need money to:
- Consolidate credit cards and other high-interest debts
- Pay for an expensive medical procedure your insurance doesn’t cover
- Eliminate primary mortgage debt for the home
- Fund an emergency expense that you can’t cover with savings
However, keep this in mind: Your home secures a home equity loan. If you default, you risk losing your house to foreclosure. It may be worthwhile to consider alternatives.
For instance, unsecured personal loans can provide you with money to cover a wide range of expenses. You don’t have to put your home up as collateral, and some lenders offer loans as high as $100,000.
You can’t deduct the interest you pay on a personal loan, but you might consider one if you don’t have sufficient equity to borrow against or would rather not put your home up as collateral.
Remember that a higher credit score can make qualifying for the best loan terms and the lowest rates easier when comparing personal loan options.
Author: Rebecca Lake