HELOC vs. Cash Out Refinance
The federal income tax code was significantly altered beginning the first of this year. Several traditional deductions such as mortgage interest deductions, state and local income tax deductions and others were changed or otherwise eliminated altogether. In exchange, income tax rates for all brackets were reduced. This was the first major tax reform since 1981. But what many homeowners with a HELOC (home equity line of credit) will notice is the interest deductibility in 2018 and beyond.
What is a HELOC (Home Equity Line of Credit)
A home equity line of credit, or HELOC is indeed an equity loan but instead of one lump sum issued at the closing table a revolving line of credit is issued. This line of credit works very much like a credit card. A line of credit is approved using available equity in the subject property. Borrowers can take out a HELOC and use the funds as needed and pay back the amount borrowed over time, as a lump sum payment or some combination of both. And because a HELOC is classified as a mortgage because it is secured by real estate, the interest paid could be tax deductible.
Tax Deductions are Changing
No longer. The tax reform eliminated HELOC interest from being tax deductible. While being able to deduct interest on a HELOC is not the primary motivation for taking one out it was certainly a benefit. If interest on a HELOC accrued to say $10,000 for one calendar year and the borrowers were in the 24 percent tax bracket, they could deduct that interest from taxable income. But now that feature has been eliminated.
But that doesn’t mean borrowers can’t tap into their equity. Note that equity loans haven’t been eliminated either but the interest deduction is capped at $100,000 up to the first of this year. Going forward, equity loan interest deduction is eliminated unless the funds were used to remodel or otherwise upgrade the home. For most, that’s not going to be an issue as the equity cap is still rather generous.
For those who want to refinance and also pull out some extra cash while still maintaining income tax deductibility, the cash-out refinance is still available. When borrowers decide to refinance to a lower rate or switch from an adjustable-rate mortgage to a fixed rate loan they can also tap into the equity in their home using a conventional mortgage. Interest on a conventional loan still falls under the standard mortgage interest deduction and not under the HELOC rules.
What’s Next
Finally, before you make any decision regarding income taxes and deductibility, you should speak with your financial planner or CPA. But if you want to know more about what these new tax changes mean as it relates to home finance, call me and let’s talk.
