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How the New Tax Bill Affects Home Equity Loan Borrowers

Until the end of 2017, the interest on home equity loans was mostly tax deductible. However, when President Trump signed the Tax Cuts and Jobs Act of 2017 into law on December 22, 2017, that interest deduction now depends on the purpose of the loan.

How does it work now? In summary, the table below outlines how the loan use will impact the tax treatment of the loan:

Under the new tax law, the interest on your home equity loan is tax deductible only if it is used to acquire, construct, or substantially improve a qualified residence. In IRS lingo such a debt is called “acquisition indebtedness.” In other words, if your home equity loan is used to refinance your original mortgage or to finance a home improvement project, then the interest paid may still be tax deductible. On the other hand, if you’re taking a loan to pay off consumer debts such as credit cards, student loans, personal loans, or auto loans, or to pay for major expenses, such as medical bills, vacations, weddings, or other large purchases, then the interest paid will no longer be tax deductible.

These changes also apply to cash out refinances. A cash-out refinance is when you refinance your primary mortgage to borrow money above and beyond your outstanding mortgage balance. As with a home equity loan, you need to determine whether the cash out portion will be considered "acquisition indebtedness.” In other words, whether the cash out portion will be used to improve your home.

However, this is relevant only if you will continue to itemize your deduction under the new law. As per the recent changes, the standard deduction has increased substantially from $12,700 for a married couple filing jointly to $24,000 (for single filers, this number changed from $6,350 to $12,000). At the same time, the deduction for state and local taxes paid in any tax year has now been capped at $10,000, including real estate, personal property, and income taxes. This means that it makes sense to itemize only if your interest on home equity loans plus other deductible items exceeds $14,000. According to research from the Tax Policy Center, 30% of individual tax filers itemized their deductions in 2015. Under the new tax law, that share is expected to be cut in half. So if you are like the majority of tax filers, then you would not itemize going forward and the question of tax-deductibility is irrelevant to your decision about whether to take out a home equity loan.

So for most borrowers, the changes for home equity loan interest under the new tax bill are likely to be less critical. Interest rates, monthly payment amounts, and fees may be more important factors when considering your financing options. Nevertheless, tax law is complicated and every household's situation is different. If the tax deductibility of your home equity loan interest is important to you, consult your personal tax advisor about how the new tax bill will impact you.

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