There is a good chance that you will reach a time in life when you are inclined to borrow money for one purpose or another. You may need a loan to renovate your home, repair your car, or pay for college. Or you may want this money to give you a well deserved vacation.
You have several options for borrowing money at your disposal. Personal loans are an option if your credit score is good, and you can also charge expenses on a credit card and pay them off over time. But personal loans are not always easy to get, and credit card debt is generally bad news. This is why you might consider borrowing on your home, provided you have enough equity to do so. Not only is it generally an affordable option, but it can offer tax advantages to get started.
What is a home equity loan?
A home equity loan is a loan you take out based on the total amount of your home you own. With a home equity loan, you borrow a certain amount and then pay it off at a fixed rate over a predetermined period of time.
You may think that a home equity loan can only be used to improve an existing property, but that is not true. You can take out a home equity loan for any purpose. But a home equity loan that you use to renovate your home may be deductible on your tax return.
What Are the Benefits of a Home Equity Loan?
Home equity loans are attractive for a number of reasons. First, they are easy to obtain, provided the equity in your home is there. Second, you will usually get a competitive interest rate on a home equity loan and a fixed interest rate at that, which makes your monthly payment on this loan predictable. Finally, a home equity loan can serve as a tax deduction – but only in limited circumstances, as we will see below.
What is the difference between a home equity loan and a home equity line of credit?
In fact, you have two choices when you want to borrow against your home. Your first choice is to take out a home equity loan and pay it back over time. Your second option is a home equity line of credit, or HELOC. With home equity lines of credit, you don’t borrow a lump sum from the start. On the contrary, you have access to a credit line that you can use at any time as long as the HELOC is active (which can be up to 10 years).
If you are not sure how much you should actually borrow, a HELOC may be a better choice than a home equity loan. This way you get more flexibility and you don’t have to pay back an amount you don’t need. And as is the case with interest on a home equity loan, interest on a HELOC is tax deductible in certain circumstances.
How Do Home Equity Loans Affect Your Taxes?
Most of the time, when you take out a debt, it cannot be used to reduce your taxable income. But in some cases, the interest you pay on a home equity loan or HELOC can be used as a tax deduction.
If you use a home equity loan or HELOC to renovate or improve your home, the interest you pay is tax deductible. But if you use this money for other purposes, it will not be used as a tax deduction. This includes home repairs – you cannot deduct home equity loan interest if you use the money you borrow to repair a cracked foundation or repair a damaged roof.
The rules around home debt used to be different. Before the 2017 Tax Reduction and Jobs Act, you could deduct the home equity loan or HELOC interest, regardless of the amount spent. But tax law has changed since then, and now the IRS only allows you to claim a deduction for money spent on improving your home. And to be clear, this improvement must be one that adds value to your home or extends its life. Finishing a basement usually matters, but aesthetic improvements like painting don’t usually fly.
Of course, whether you can claim a mortgage interest deduction will depend on another key factor: whether you take detailed deductions on your tax return or stick to the standard deduction. If you detail, you can take advantage of a multitude of tax breaks – you can claim a mortgage interest deduction, write off your property taxes (or a portion of them, depending on what that number implies), and deductions without home ownership, such as charitable giving.
What tax relief can a home equity loan give you?
Under the Tax Reductions and Jobs Act, owners who are married and jointly producing can deduct mortgage interest on loans up to $ 750,000. This includes interest on a primary mortgage, a mortgage for a second home, and interest on a home equity loan or HELOC. For those who are married filing separately, this threshold is reduced to $ 375,000 per filer. As such, if you are married and filing jointly and already have a mortgage of $ 750,000, you will not be able to deduct the interest from the home equity loan. Otherwise, you can deduct the interest on a home equity loan guaranteed by your primary or secondary residence.
Why are tax deductions valuable?
Tax deductions are used to significantly reduce your adjusted gross income. Suppose you can claim a deduction of $ 10,000 on your tax return. It is $ 10,000 in income that the IRS will not tax. The result? Additional savings for you.
How do I know if I need to itemize my taxes?
Whether the detail of your tax return makes sense to you will depend on whether your specific deductions exceed the standard deduction, which changes from year to year. In 2020, the standard deduction is:
- $ 12,400 for single filers or married persons filing separately.
- $ 24,800 for married persons filing jointly.
If you don’t pay a lot of mortgage interest, have low property taxes, and pay only a modest amount of interest on a home equity loan or HELOC, the detail may not make sense.
If you are unsure how your home equity loan will affect your taxes, it is a good idea to consult an accountant or tax advisor for more information. But remember, even if you don’t get tax relief on a home equity loan, it can still be an easy and affordable way to borrow money when you need it.
What Are The Main Benefits Of Comparing Car Insurance Quotes Online
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