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Tax Deduction Tips For Home Equity Loans
By EchoBay Loans Staff Writer

A home equity loan is a loan that is secured by your home. It is a second mortgage interest in your home and a way to cash in on the equity you have built in your home without putting up a for sale sign. Home equity loans can also offer tax advantages to some. As with any possible tax deduction, you should consult your tax advisor for advice on your individual situation.

For many people, the added benefit of deducting interest payments on their taxes is enough to take out home equity loans. This loan can be used for any reason and the reason does not have to be tied into your home. Some are using home equity loans to buy a new car or boat, while others are using it as a way to pay for their child's college education. No matter what the reason, because the loan is secured by your home, some of the interest can be tax deductible.

Mortgage Interest Tax Deduction
For those who are married filing jointly, the IRS allows interest to be deducted for home equity loans up to $100,000. This maximum can be met by one loan or by several loans secured by a first and second home. Of course, you must exceed the standard deduction to reap this benefit. But it can be quite a benefit. For a $100,000 equity loan with an interest rate of 7%, you've paid $7,000 in interest that could be tax deductible.

Taking advantage of this can offer savings for you when it comes to buying any item using your equity. Home equity loan rates are generally low and when coupled with the tax savings, the net effect of the interest rate can be even lower.

If your home equity loan is for the purpose of substantial improvements to your home, it most likely will fall under the same guidelines for interest deduction for a mortgage rather than a home equity loan. In this case, the total debt allowed for all mortgages for those married filing joint is $1,000,000. This includes any debt on a first or second home. You cannot deduct interest for more than $1,000,000 in loans. If you exceed this loan amount, it is possible the overage could count towards your home equity loan amount. You should check with your tax advisor.

The Catch
There is one catch to the home equity loan tax deduction. The IRS only lets you deduct interest loans equaling to the current value of your home. For instance, if you have a $160,000 home and your first mortgage is $120,000, you could technically get a home equity loan for 125% of the value of your home or $80,000. According to the $100,000 maximum loan amount, you would still be able to deduct all of the interest. Not so fast!

This puts the total amount of debt against your home at $200,000, which is $40,000 more than your home is worth. The IRS will only allow you to deduct interest on loans that equal the value of your home. In this scenario, you would only be allowed to deduct the interest on the first $40,000 of your home equity loan.

Deducting Points
Although many home equity loans offer little or no closing costs, some will have points associated with the upfront costs. Points are fees that are calculated as a percentage of the loan amount. There is a set of IRS guidelines that you must meet in order to be able to deduct all the points in one year. If you do not meet all of these guidelines, you may amortize the points over the life of the loan.

To see how amortizing the points would work, let's look at the following example. Bob took out a $50,000 home equity loan for 10 years and paid three points. Three points on $50,000 is equal to $1,500. Bob would divide $1,500 by the number of months in the loan term (120). This results in a monthly deduction of $12.50. At year-end, Bob would be able to deduct $12.50 for each monthly payment he made in that tax year.

You should always check with your tax advisor regarding tax-deductible interest. In many cases, it is a simple calculation. When multiple mortgages and homes are involved, it can become quite complicated. But the benefits of the tax deduction usually far outweigh the headaches involved in arriving at the correct figure!


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