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:
- college tuition
- medical expenses
- blow-out vacations
will no longer be able to deduct the loan interest from their taxes.*
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!**
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.
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.”