Holy HELOC Batman, What Do We Do Now?

Running from the change in the HELOC interest deduction in 2018

BAM! KAPOW! BIFF!

One of America’s favorite tax deductions – interest payments on a home equity line of credit (HELOC) – just got taken to the woodshed by the passage of the new Tax Cuts and Jobs Act of 2017 (TCJA).

It’s true, the glory days of the HELOC are officially over.

Why? Because homeowners who used HELOCs to pay for things like:

  • cars
  • college tuition
  • medical expenses
  • weddings
  • blow-out vacations

will no longer be able to deduct the loan interest from their taxes.*

New and existing borrowers loose the home equity interest deduction in 2018

While this may be a cruel blow for itemizing homeowners, all is not lost.

There are still some benefits to HELOCs, including one major exception under which the interest remains deductible. So let’s look a little closer at the history of the HELOC, the changes made under the new tax law, and just where in the HELOC we go from here.

What is a HELOC?

A HELOC is a loan that is secured by the equity in your home. Instead of the loan being a set amount (like a second mortgage), the HELOC allows you the flexibility to borrow up to a certain limit during a defined term. The interest rate is not fixed. It is variable and tied to an index or benchmark, such as the prime rate. Your HELOC repayment consists of the amount of proceeds that you’ve drawn down, plus the interest, amortized over the loan term.

Your HELOC is secured by a real asset – your home. If you fail to pay your loan, the lender has certain rights to claim an ownership interest in your home. And yes, we are talking about the F word – foreclosure. Because HELOC lenders enjoy foreclosure rights, they offer rates on HELOC loans that are rather low (usually under 5%). HELOC rates are substantially lower than the rates available on unsecured loans (such as personal loans or  credit card advances).

Are HELOCs Still Available?

Yes, totally.  And because they offer low interest rates and flexibility, HELOCs are here to stay. They will continue to be a popular, lower-cost way to borrow money for some of life’s big expenditures.

But…alas….HELOCs ain’t what they used to be. Because prior to the passage of the TCJA, there was that extra special layer of HELOC awesomeness. No matter what you decided to do with the proceeds of your HELOC….

Your interest was tax-deductible!**

Happy homeowners were able to deduct interest on home equity lines prior to new tax laws passage

Why is that so special?

As a general matter under the tax code, personal interest is NOT tax-deductible. Prior to the TCJA, however, the HELOC provided homeowners a nice way around the rule. In fact, homeowners could use HELOC proceeds to buy anything, up to $100,000, and write off the interest payments on their taxes. Want to pay for college? Write it off. Want to buy a car? Write it off. Want to pay off old credit card debt, go on a cruise, get lots of tattoos? WRITE IT OFF!

But…all good things must come to an end, and these tax deductions have come to a screeching halt. As of 2018, no HELOC interest will be tax-deductible on loans used for personal expenditures. In addition, there will be no grandfathering of existing HELOCs taken out prior to the passage of the TCJA. These deductions are disappearing for BOTH new and existing borrowers.

2018 tax laws end home equity interest deduction

So it’s game over for deducting HELOC interest in most cases…but, there is still ONE big exception that allows for the deduction of HELOC interest.

HELOCs to Fund an Acquisition

HELOC interest is still tax-deductible when the proceeds are used for “acquisition indebtedness.” Acquisition indebtedness includes any mortgage debt used to buy, build, or substantially improve your primary residence. This means that even if you take out a HELOC long after you buy your home, your HELOC interest will be tax-deductible so long as you use the loan proceeds to do major home renovations or build an expansion. So, if the loan money is going right back into the house, BINGO, you can deduct that interest.

What if you refinance your existing mortgage with a “cash-out refi”? In other words, what if you borrow more than you currently owe on your initial mortgage? It all depends on what you do with the cash-out portion. If you use the cash for substantial home improvement, it’s deductible. If you use it to pay off old credit card debt, it is no longer tax-deductible.

The Upshot on HELOCs

Because of the low rates and the continued interest deductibility for acquisition indebtedness, HELOCs remain an excellent way to finance substantial home renovations. Even without favorable tax treatment, a HELOC used to finance property acquisition or improvement is considered “good” debt. Why good? Because it can increase your asset value over time, increasing your property appreciation and improving the return on your home investment. You took that loan money, invested it, and made it grow.

In the case of non-acquisition HELOCs, even though their interest is no longer deductible, they will likely remain popular for major life purchases (like automobiles or college tuition) and for emergencies (like major medical expenses or unexpected job losses). A HELOC used for these purposes still provides a homeowner access to lower borrowing costs and a fair amount of flexibility in most circumstances.

As for using HELOCs to fund day-to-day or discretionary expenses, well, let’s just say that there are not a lot of fans of the idea. Using a HELOC in this fashion is a “bad” debt move. Why bad? Because you would be using the low interest rate loan to live beyond your means, funding life’s little extras, not your necessities. In fact, it may be that the TCJA targeted HELOC deductions to discourage borrowers using HELOCs to take on more bad debt.

Final Note Regarding HELOCs and Itemization

In order to get the benefit of a HELOC interest deduction, you are required to itemize your tax deductions using Schedule A on your 1040. After you complete Schedule A, you then determine whether you have a higher deduction by itemizing or if you are better off claiming your allowable standard deduction.

Because the TCJA vastly increased the amount of the standard deduction, many people who formerly itemized will no longer opt to do so.

Under the new 2018 rules, the Standard Deduction will be $12,000 for individuals and $24,000 for married couples, as compared to just $6,350 for individuals and $12,700 for married couples under current 2017 law.

This vast increase in the standard deduction may render the whole issue surrounding HELOC interest deductibility moot for you. Because even though you may be losing the ability to claim a HELOC deduction next year, you might be saving more money in taxes by simply claiming the increased standard deduction. This is a matter between you and your CPA (or between you and Turbo Tax and a bottle of gin, as the case may be).

Try to Enjoy the TCJA and Have a Happy New Year!

 

*The TCJA actually suspends the home equity indebtedness deduction through December 31, 2025. After that it could potentially be reinstated as the suspension sunsets.

**Prior to the TCJA, the tax deductibility of HELOC non-aquisition debt was limited to loans that, throughout the year, totaled $100,000 or less ($50,000 or less if married filing separately). Additionally, the loans must not have totaled more than the fair market value of the home, as reduced by “grandfathered debt” and “home acquisition debt.”

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23 thoughts on “Holy HELOC Batman, What Do We Do Now?

  1. Very interesting, I hadn’t heard that this had changed. We don’t have one setup currently but I know people that do and say it is a smart way to go. Hope you have a very happy New Year!

  2. Great post, and so many things to unpack in this new tax reform!

    I am curious how this change to the HELOC rules will affect the housing market.
    Specifically if people will tend to rent more since the benefits of borrowing against your home equity line for personal debt has been nix’d.

    1. Very intuitive comment MissSaraBee. Theoretically, the loss of this added tax benefit should act to depress housing demand. On the flip side, the TCJA retained the home mortgage interest deduction (up to certain limits) so there is still tax incentive to be a homeowner. But, then again, with the standard deduction increase, fewer people will itemize and the home mortgage interest deduction will be less useful….so, like you, I’m very curious to see what happens to housing prices in 2018!

  3. I knew there were plans to limit home interest deduction, but I had no idea this was changing. It is rough on people that recently paid fees to set up HELOC’s.

    1. You are right…they just got screwed. Hopefully they got some benefits from the TCJA to offset their loss!

  4. Interesting- I don’t keep up with the tax changes given that I’m from Canada, but we have HELOCs in Canada.

    For us the mortgage interest is NOT tax deductible UNLESS its for an investment property (e.g. non primary residence). The only way to make your primary residence tax deductible is to use a HELOC to invest in the market. It’s called the Smith Maneuvre.

  5. The Smith Maneuver…I like it! So you could have done the same thing with a HELOC loan prior to the TCJA by investing the loan proceeds in the market. No longer. However, I believe you can still invest in rental real estate with HELOC proceeds on your primary home and write off the interest (as a form of acquisition indebtedness). I want to confirm that though and then include the info in a future real estate investing post.

    1. Follow-Up regarding rental property investment: You can still take a HELOC on your primary residence, use the money to purchase a rental property and deduct the interest as an expense against your rental income (on Schedule E). You can no longer deduct the first $100,000 on Schedule A as you may have done in the past.

  6. Informative post Kat! I thought the HELOC interest deduction went away completely! We finished paying off ours in December and I wasn’t planning on using it again for this reason. The only thing we were planning on using it for in the future was to help with a kitchen remodel, so it is nice to know that this will still be deductible.

    How do you denote on your taxes whether it was for an acquisition? If you use some HELOC money for a home improvement and some to play the slots, is the individual responsible for calculating how much interest is applied to each?

    1. Thanks Mr. Widget! And nice to hear that you should be able to deduct future HELOC interest for your anticipated home renovation. Although it’s possible tax reporting forms might change for 2018, my guess is that schedule A will remain basically the same. Thus, you would continue to report your HELOC interest (as reported on Form 1098) on Line 10. It is up to you to do your own figuring (according to the updated IRS Schedule A instructions) and your own receipt gathering to support the inclusion of your HELOC interest on Line 10. In other words, save the receipts from your remodel in your tax files to support your deduction if you are ever audited. And, knowing you Mr. Widget, I have no doubt that you would do this! 🙂

    1. Good question. Basically, the total amount of acquisition indebtedness that you can deduct for both a primary and second home is capped at a total $750,000 in 2018. (The initial House Bill had proposed excluding second homes, but this was not in the final law). The $750,000 amount can include a HELOC that was taken out on your primary home to purchase your second home (because that makes it “acquisition indebtedness”) so long as it fits under your total cap of $750,000 (for married filing jointly, $375,00 for married, filing separately).

        1. Yes, as long as all of the re-fi proceeds go toward paying down the existing purchase money mortgage and/or is used for that plus acquiring the second home (or substantially remodeling either home). That would all qualify as acquisition indebtedness. But if you re-fi for more than your existing mortgage and take the extra money out to purchase a car, the extra cash-out would not qualify and you could not write off the interest on that portion.

  7. Hi Kat, great post! (this is my second comment, first one seem to have vanished!)
    I have used HELOC for all my rentals, the only way I could get it done and I get to write off the interest, just love it .
    In Canada, it has always been the only way you can write-off the interest (for investment purposes) so no changes here.
    Happy New Year to you and your family.

    1. Hey Caroline! I think your old post was my fault, sorry! Smart phone struggles – I clicked approve and then must have clicked unapproved with my happy thumb, sorry! Anyway….I am totally with you on using HELOCs for real estate investing. It is also the method I used to purchase most of my rentals. There is nothing like being able to access that tied-up money to grow your wealth. And, happily for investors everywhere, that HELOC interest will still be deductible against rental income! Yay! Now I’m off to comment on your latest post about DIY landlord nightmares…the evil underbelly of real estate investing!

  8. Landlord nightmare? What nightmare?? Oh you mean the burst pipe and flooded basement? LOL. Feeling a little better about it now that I can actually think! but still a real pain to deal with.

  9. Your gifs are gifts. Bwahahahaha! Is the interest on a HELOC deductible if it’s used to purchase another property? That’s what I considered doing to get my hands on an income property.

      1. Cool, glad you saw that thread! And I think I said somewhere in there that I love using a HELOC for purchasing a rental. It is a realistic way for people who have some level of assets, but no cash sitting around (most money is tied-up in retirement accounts and a primary residence). So a HELOC is truly a good way to get started!

  10. Any deductions like that I look at as a ‘bonus’ and therefore, I try not to get too upset when they’re taken away. I never had a HELOC so this is one advantage I sadly never used, but if you look at it as a bonus and not something you count on, it can definitely make it easier to say goodbye.

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