Tax Reform: Thinking about a home improvement loan? Here are some things to consider.

Jennifer Dier, March 12, 2018
In December 2017, Congress passed a major tax reform bill called the Tax Cuts and Jobs Act of 2017 (TCJA).  The new tax laws impact a wide range of topics ranging from our individual tax rates to new deductions and credits. Here are some details about how the new tax rules impact home equity lending.
Thinking about a home improvement loan?
  
What is a home equity loan?
Home equity loans and lines of credit can be taken out by homeowners using the equity in their homes as collateral. Equity is the difference between the market value of a home and the remaining balance on the mortgage. A home equity loan is a one-time loan with a fixed interest rate. A home equity line of credit is a revolving line of credit and acts much like a credit card with a specific credit limit based on the amount of equity in the home.
 
Old rules
Prior to 2018, interest paid on mortgages used to purchase a home was deductible up to $1,000,000 and interest on home equity loans and lines of credit was deductible up to $100,000 from their taxes regardless of what the loan was used for.  As long as the loan was secured by the home, the interest was deductible. 
 
The rules are changing in 2018
The TCJA imposes new limits for tax filers, but it doesn’t completely eliminate the deductibility of interest paid on home equity debt. Beginning in 2018, provided certain requirements are met, interest on “acquisition debt” will be limited to $750,000. Acquisition debt consists of both the first mortgage and any subsequent home equity loans taken on the property.
 
The difference is based on borrowing purpose, or what the loan will be used for. There are now two categories for the type of debt that is incurred:
  • Acquisition Indebtedness – This is debt used to buy, build, or improve your home, and will continue to be deductible.
  • Home Equity Indebtedness – This is debt used for any other purpose. Interest for these purposes will no longer be deductible.
 
As long as borrowers use home equity funds to purchase or make substantial improvements to their homes, the interest will continue to be deductible up to the $750,000 acquisition debt limit mentioned above. Borrowers should keep records of home renovation expenses so they can provide evidence of the purpose starting with the 2018 tax year.
 
Borrowers have traditionally used home equity funds for a variety of purposes – vehicle purchases, vacations, tuition expenses and high interest debt consolidation – knowing they would be able to deduct the interest on their tax returns. With the change in the tax law, interest on equity debt used for these purposes will no longer be deductible. This doesn’t mean that equity debt can’t be used for these types of purchases, just that the interest will no longer be deductible for the 2018 tax year.  
 
Is home equity lending still an attractive lending option?
Yes. Home equity loans and lines are a useful and popular source of extra funds for a variety of reasons:
  • Low-cost; the interest rate on home equity debt is generally lower than credit cards or other types of unsecured debt
  • Flexibility
  • Fixed payments option makes payments manageable and predictable
  • Important source of emergency funds
 
If you have questions about the implications of the new tax law, you should consult with your tax advisor before taking out a home equity loan or line of credit.
 
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This article is educational and informational in nature, and not intended to be used as tax, legal or accounting advice. Consult your tax advisor regarding interest deductibility and any other tax needs.
 
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