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The tax implications of home equity loans depend, in part,
on the kind of home equity loan you are considering. There are several types
of home equity loans, but there are three that concern us here:
a traditional home equity loan; a no-equity home loan; and a reverse mortgage.
A traditional home equity loan is one in which you borrow against the equity
you have in your home (typically built up from paying off the primary or purchase
money loan). When you take out a traditional home equity loan, chances are you
are taking the cash value of your equity out of your home. In other words, you
are doing a cash-out refinancing. The I.R.S. permits you to
take up to $100,000 cash out of the equity of your primary residence and still
deduct the interest before the loan is repaid. The $100,000 limit is if you
are married and filing jointly, the limit is $50,000 if you are single or married
and filing separately.
Another thing to be aware of with home equity loans is that, unlike with purchase
money loans, you may not deduct interest
points in the year you pay them, but must amortize the deduction over the
life of the loan. Points, as you probably already know, are paid at closing
and are equivalent to a certain percentage of the total amount of the loan.
So, if at the closing of your home equity loan, you pay one point equal to $3,500,
you cannot deduct all of that $3,500 in this tax year. You can only deduct a
portion of the $3,500 each year of the loan. The I.R.S. will cut you a little
bit of a break, though. If you refinance the home equity loan, you can deduct
all of the remaining point balance in that tax year.
A no-equity home loan is similar to a traditional home equity
loan in both name and structure, but is a different tax beast entirely. With
a no-equity home loan, you can borrow more than the amount of equity you have
in your home, sometimes up to 25% more. These loans are extremely risky, so
you pay higher interest rates and fees to get them, but to add insult to injury,
the I.R.S. does not allow you to deduct the interest on any loan amount that
exceeds the value of your home.
A reverse mortgage is also a loan against the equity of a
home, but in this case, the mortgage lender pays the borrower a lump sum, monthly
payments, or extends a line of credit and the borrower makes no payments at
all. Interest accrues over the life of the loan which is paid back out of the
estate of the borrower on the death of the borrower (or sometimes it's just
paid back after a period of years). This type of loan is limited to those over
age 62 and generally requires that the home be completely or almost completely
paid off. The money paid to the borrower is tax-free, but no there is no interest
deduction until the interest is actually paid (which it would be when the loan
is paid off).
For more information about the tax implications of home equity loans, download
I.R.S. Publication 936 Home Mortgage Interest Deduction from the I.R.S.
website, www.irs.gov.
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