A home equity line of credit (HELOC) and a home equity loan both free up cash by accessing the equity you have in your home. In both cases, the interest charges may be tax-deductible. The HELOC is a line of credit, usually with an adjustable interest rate, which will turn your equity into cash. It normally has a 10-year time period during which you can make draws up to your credit limit; the second 10-year period is the repayment period. A home equity loan also uses your home equity, with the loan amount distributed to you as a lump sum instead of a line of credit and typically has a fixed interest rate.
A financial advisor help you decide if a HELOC is right for you. To find one quickly, use SmartAsset’s free advisor matching tool today.
Tax Rules and Home Equity Deductions
The Tax Cuts and Jobs Act was enacted effective Jan. 1, 2018, and mandated sweeping tax reform. Home equity loans, including the HELOC, and the tax deductibility of their interest charges were impacted. The tax effect of the law on HELOCs and other home equity loans was to limit the tax deductibility of interest to how you spend the loan.
For the interest charges to be tax deductible, the proceeds of the line of credit must be spent on the property that was used for collateral. The tax code states the loan must be spent to “buy, build or substantially improve” the property on which the line of credit is based. The interest is deductible if you use the proceeds to renovate your home. This is the law until the Tax Cuts and Jobs Act expires in 2026.
Unless you itemize deductions, the interest you pay on a HELOC is not going to help you. Fewer people have itemized since tax reform due to an increased standard deduction. For 2022, the standard deduction is $25,900 for married couples filing jointly and $12,950 for single individuals. As a result of the higher standard deduction, itemizing may not be beneficial to you. In that case, the interest you pay, even for property renovation, on a HELOC will not be deductible.
New Deduction Limits
Since the 2018 tax reform law, the tax deductions limits have changed on all mortgage and home equity debt. You can only deduct interest charges on a maximum of $750,000 in residential loan debt including HELOCs if the line of credit was approved before Dec. 15, 2017. If your HELOC was approved before that date, you may fall under the old limit of $1 million. Check with your tax advisor to be sure.
Before the 2018 law, you could only deduct a maximum of $100,000 in home equity debt. However, you could take that deduction no matter how you were going to spend the money from your HELOC or home equity loan. It didn’t have to be just on property renovation. Now, you can be approved for a HELOC for a variety of reasons in addition to home renovations like paying off high interest credit card debt or funding a college education. However, interest deductions cannot be taken for these purposes.
Benefits of Taking Out a HELOC
Since the pandemic, HELOCs and home equity loans have been harder to get. In fact, two of the major financial institutions, Wells Fargo and JPMorganChase stopped accepting applications for them altogether due to market conditions. If HELOCs grow scarcer, the cash-out refinance market is likely to grow.
However, if you can get a HELOC, there are benefits beyond the interest deduction. For example, you pay interest only on the amount of the HELOC that you draw down. If you get a home equity loan, you pay interest from the first on a large lump sum. HELOCs save you money. You also usually have a 10-year time period before you start repaying the principal. During the first 10 years, you only repay interest.
Since a HELOC is a line of credit, you borrow only what you need when you need it. Some lenders have started offering a fixed interest rate on HELOCs, which have traditionally carried an adjustable interest rate. There are also few restrictions on how you can use HELOC funds. Accessing the funds from a HELOC is usually as simple as writing a check.
HELOCs are good for consumers who are disciplined in making on-time payments. However, you have to remember that even though the benefits of a HELOC are numerous, there are also disadvantages. You are tapping into your home’s equity and putting your home at risk if your income drops, you lose your job or some other event that you can’t predict occurs. The interest rate on a HELOC is variable, so in a rising interest rate environment, a HELOC may not be a good financial choice.
Tips For Home Buying
- It may be wise to contact a financial advisor to help you determine if a HELOC is the financial product for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Homebuying isn’t always the simplest process. SmartAsset has a number of free online tools that can help answer you questions. For example, are you curious about what property taxes will be on your home? Use SmartAsset’s property tax calculator and find out.
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