Home Equity Line Of Credit (HELOC): How It Works & Tax Rules To Know
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I know and work with a lot of people in the personal finance space.
I’m also not easily surprised.
When it comes to this topic and this group, in particular, I was taken aback.
So many people had no clue what I was talking about when I mentioned a HELOC.
If they didn’t know what it was, regular folks like yourself might not either.
And that’s not acceptable to me, so here we are getting you informed!
The acronym stands for Home Equity Line Of Credit if you didn’t know.
It’s a way to get money out of your home (we’ll get into all the details later).
If you’re a homeowner, it’s something you should have an understanding of.
Even if you don’t own a home at the moment, you should still get familiar with it in case you get interested in home ownership in the future!
Remember, this is just an introduction, a crash course if you will, to teach you the basics so you at least know what a home equity line of credit is when you come across it later on in life.
What is The Home Equity Line OF Credit?
As the name states, the home equity line of credit is a specific type of credit.
That means, like all other types of credit, it needs to be paid back eventually.
One difference is that a HELOC isn’t based solely on your credit score or income.
Instead, the amount of your credit line is based on your home’s equity: the difference between your home’s current (appraised) value and the balance remaining on your mortgage (if you have one).
Another difference is in how the HELOC is structured.
Your home secures it, so it’s like a mortgage in that regard.
On the other hand, it’s a revolving line of credit, so it’s like a credit card.
The thing that sets it apart from both is the way in which you repay the money you take out.
With a HELOC, you only pay interest on the outstanding balance each month and don’t get penalized for not paying any principal the way a credit card works.
How To Access Funds From Your HELOC
Getting money from your home equity line of credit is just as easy as using your normal bank account.
Most banks and credit unions give you the option to access your funds via:
- Writing a check
- Paying with an access card (similar to a debit card)
- Doing an online transfer
It’s really that simple.
Unlike a mortgage or a personal loan, you don’t have to take the money upfront, all at once.
You can access it whenever you need.
You also don’t have to ask for permission, and you don’t need to submit a request for reimbursement.
It really is that easy.
What Can A HELOC Be Used For?
The simple answer?
You can use the funds from a home equity line of credit for anything you want to use it for.
You can use the money for:
- Debt reduction/consolidation
- Home repairs
- Acting as your emergency fund
- Medical expenses
- Home improvements
Or you can use it for anything else you can imagine, there are no restrictions (although I’m pretty sure it has to be legal 🤣).
But, if you want to be able to deduct the interest on HELOC funds, then you definitely need to read the next section!
is HELOC interest tax deductible?
Pre-2017 tax year, you would be able to deduct the interest you pay for your HELOC on your income tax return (if you itemized, of course!).
Starting January 1, 2018, however, The Tax Cuts and Jobs Act of 2017 took effect changing the rules for deducting HELOC interest.
No longer can you deduct interest for just anything.
Now, you can only deduct the HELOC interest if the money was used for:
- Buying a home
- Building a home
- Substantially improving a home
In addition, the residence used to secure the home equity line of credit has to be the same home.
Yes, I agree that the IRS rules make absolutely no sense since you can’t buy or build a home under these criteria and (potentially) get the tax deduction, so why even include those options?
For example, you own one home and get a HELOC, using the proceeds to build an add-on. The interest on that money would be allowable to be deducted (if you itemize).
On the other hand, if you use that same money to buy land and build a second home you wouldn’t be allowed to deduct the interest because the money was spent on a home that doesn’t secure the HELOC.
In addition to the use rule, there is now a maximum of $750,000 in total principal across all mortgages, home equity loans, and home equity lines of credit for primary and second homes for all of the interest to be deductible.
Once the total principal exceeds $750,000 the deductible interest on those loans will be limited based on that principal (you can find the limiting percentages in IRS Publication 936).
So now you have to be very careful about what you use the proceeds for in order to be able to deduct the interest.
This is especially true if you DIY taxes using one of the tax apps!
Of course, if you don’t itemize it really doesn’t matter since you can’t deduct any interest!
That explains the basics of the home equity line of credit.
It’s really not something terribly complex or hard to understand about it.
Summarizing it quickly:
- It’s a line of credit, not a traditional loan
- The amount is tied to the equity in your home
- It can be accessed any time for any reason
- The interest is deductible under limited circumstances
Hopefully, you now have an understanding of how it can help you in your financial life!
Were you aware of the home equity line of credit before reading this article? Have you had personal experience with it before? Do you still have questions that weren’t addressed above?