You have several choices for borrowing money at your disposal. Personal loans are an option if your credit score is good, and you could also charge expenses on a credit card and pay it off over time. But personal loans aren’t always easy to qualify for, and credit card debt is generally bad news. That’s why you might consider borrowing against your home, provided you have enough equity in it to do so. Not only is that generally an affordable option, but it may offer some tax benefits to boot.
A home equity loan is a way to borrow money using the equity in your home as collateral. Not only can you lock in a lower interest rate than you’d typically get with a credit card or personal loan, but you can also deduct the interest on your taxes in some cases.
But the rules for home equity loans and taxes can get complicated, plus they’ve changed under the Tax Cuts and Jobs Act of 2017. Keep reading to learn about when you can qualify for a tax deduction on home equity loan interest.
What is a home equity loan?
A home equity loan is a type of second mortgage you take out based on the amount of your home you own outright. You borrow a certain sum from a home equity loan lender and then pay it back at a fixed rate over a predetermined period of time. Unlike personal loans, which are usually unsecured loans, a home equity loan uses your home as collateral, which means you risk foreclosure if you can’t afford to repay it.
You can take out a home equity loan for any purpose, including debt consolidation or to pay for a wedding or vacation. But you can only deduct the interest on a home equity loan if it’s used to buy, build, or substantially improve your primary or secondary home.
When is a home equity loan tax deductible?
First of all, only the interest paid on a home equity loan qualifies for a tax deduction. You won’t be allowed to deduct any money you paid toward the loan’s principal. However, you’ll need to itemize your deductions instead of taking the standard deduction in order to deduct the interest.
How much can you deduct?
The rules vary based on whether you secured a home equity loan before or after the passage of the Tax Cuts and Jobs Act of 2017:
For home equity loans taken out before Dec. 16, 2017:
You can deduct mortgage interest, including home equity loan interest, on the first $1 million of mortgage debt. If you’re married and file separate tax returns, you can only deduct interest on the first $500,000 of mortgage debt.
For home equity loans taken out Dec. 16, 2017 or later:
You can only deduct mortgage interest, including home equity loan interest, on the first $750,000 of mortgage debt. If you’re married filing separately, you can only deduct interest on the first $375,000 of mortgage debt.
Limits on deducting home equity loan interest
The Tax Cuts and Jobs Act, or TCJA, didn’t just change how much interest you can deduct for mortgage-related debt. It also narrowed the rules for when you can deduct interest on a home equity loan or home equity line of credit (HELOC).
Before the law took effect, you could deduct home equity loan interest no matter what you used it for. If you used the funds to pay off credit card debt or medical debt, you could still deduct the interest. But TCJA suspended the deduction for home equity loans and HELOCs for tax years 2018 to 2025 unless they’re used to buy, build, or substantially improve a qualifying primary or secondary home.
Why deducting home equity loan interest may not be worth it
To deduct mortgage or home equity loan interest, you’ll need to itemize your deductions at tax time. But for many taxpayers, itemizing is no longer worth it. That’s because the Tax Cuts and Jobs Act nearly doubled the standard deduction, which is the fixed amount you can deduct on your taxes, even if you have no expenses.
The standard deduction for 2023 is $13,850 for single filers and $27,700 for married couples filing jointly. If you don’t have deductions exceeding these thresholds, you’re better off taking the standard deduction, even if that means you can’t deduct home equity loan interest. Nearly 90% of taxpayers now take the standard deduction instead of itemizing, according to IRS data.
Can you deduct HELOC interest on your taxes?
The rules for deducting interest paid on a HELOC — which is a line of credit secured by your home — are the same as those for deducting interest on a home equity loan: The money must be used to buy, build, or substantially improve a qualifying residence in order to deduct the interest.
What are the benefits of a home equity loan?
Home equity loans are attractive for a number of reasons:
- They’re easy to qualify for, provided the equity in your home is there. Even if you don’t have a great credit score, you may still qualify because the loan is secured by your home.
- You’ll generally snag a competitive interest rate on a home equity loan, and a fixed interest rate at that, making your monthly payment on that loan predictable. Interest rates are typically lower than you’d get with a credit card or personal loan.
- Finally, a home equity loan can serve as a tax deduction — but only in limited circumstances, as discussed above.
Should you itemize to deduct home equity loan interest?
Whether itemizing on your tax return makes sense for you will hinge on whether your specific deductions exceed the standard deduction, which changes from year to year. If you don’t pay a lot of mortgage interest, have low property taxes, and only pay a modest amount of interest on a home equity loan or HELOC, then itemizing may not make sense.
If you’re not sure how your home equity loan will affect your taxes, it pays to consult an accountant or tax advisor for more information. But remember, even if you don’t snag a tax break from a home equity loan, it can still be an easy, affordable way to borrow money when you need to.
