"Consult your tax advisor." That little disclaimer shows up in nearly every ad for a mortgage lending product. But who actually does that? Here are the reasons why home equity interest expense is sometimes tax deductible, and sometimes not, and why you might try consulting that tax guy after all.
Borrowers with bad credit are always being told to consolidate their debt with home equity financing. And this can be a great solution for many reasons--lowering payments, improving rates, affording home improvement, paying for emergencies, etc. And one benefit almost always mentioned is the tax deductibility of the interest.
Home Equity Interest: Is it on Your Schedule?
Your Schedule A, that is. That's where you put your mortgage interest if you itemize your deductions. If you are a borrower with bad credit, a low income, or a less expensive home, government data suggests that you are less likely to deduct your interest than a high income borrower with a million dollar mortgage. Taxpayers who have smaller mortgages and therefore pay less interest, or those who have a higher standard deduction, such as a head of household, may not reap the benefit of deducting interest. A home equity loan might still make sense, but deducting the interest is not a consideration.
How High is Too High for Home Equity Deduction?
The IRS restricts the deductibility of interest on a home equity loan to a loan amount of $100,000. This limit applies whether the $100,000 is a single loan against your main home, or the total of a combination of loans against your first and second homes.
But Wait, There's Less....
The $100,000 limit on your home equity mortgage deduction may not apply to you. If the total amount of loans against your home is greater than the home's value, you only get to deduct interest on loan balances that don't exceed the total value of your home. For example, Homeowner A has a house worth $200,000, and a $160,000 mortgage against it. If he was to get approved for and take a $100,000 second mortgage, the total mortgages against the property would be $260,000. Only the interest on the first $200,000 is deductible. The interest on the excess $60,000 is not.
But Wait, There's More......
If you are using the home equity loan for home improvement, take the above and throw it out the window. You will probably get to deduct the mortgage interest.
Now that you're thoroughly confused, you can see why most lenders ask you to "consult your tax advisor."
Mortgage Credit Problems Columnist
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