Tax reform just made home equity loans a lot less attractive
Home equity loans have long been attractive ways for homeowners to borrow money to pay for everything from major home improvements to a
child's college education. But these loans just lost a major benefit: When filing their income taxes, homeowners can no longer deduct the interest they pay on home equity loans each year.
This might make these loans less popular. The loss of the interest deduction might persuade homeowners to look for other ways to tap the money in their homes.
"From what I see, there are very limited times that home equity loans would still come in as a benefit," said Tristan Ahumada, a real estate agent with Keller Williams Realty in Westlake Village, California.
A rush to pay off home equity loans?
And she's not alone. Donald Daly, managing partner of REIS Group LLC in New York City and a licensed real estate appraiser, said that since January 1 he has seen a higher level of requests for appraisals from homeowners seeking to refinance their existing mortgage loans. Many of these owners are doing this as a way of paying off their Home Equity Lines of Credit, a form of home equity loan.
The reason? These lines of credit, better known as HELOCs, are not nearly as attractive to homeowners when they don't come with the bonus of a tax deduction.
"We fully expect this trend to grow over the next weeks and months as more and more homeowners learn of the effect these changes will have on their personal finances," Daly said.
In the past, homeowners who took out home equity loans or HELOCs could deduct the interest they paid on up to $100,000 of these loans. If you took out a home equity loan for $50,000, then, you could deduct all the interest you paid during the year on that loan. If you took out a home equity loan for $150,000, you could deduct the interest you paid on the first $100,000 of that loan.
When Congress in December of last year signed the Tax Cuts and Jobs Act into law, this all changed. The big tax reform legislation eliminates the home equity loan deduction starting in 2018. You can still claim your tax deduction when you file your income taxes in April of this year. That's because you're paying taxes from 2017.
But you won't be able to claim the home equity loan deduction when you file on your 2018 taxes and beyond. Most of the tax cuts impacting taxpayers, including the home equity deduction rules, are scheduled to expire after 2025. No one knows, though, whether Congress will vote to continue them past that date once that year rolls around.
Existing loans aren't grandfathered in, either. If you took out a home equity loan in 2016 and you're still paying it off this year, you won't be able to deduct any interest you pay on it in 2018, even if you've already deducted interest payments in the past.
The other equity option
Now that the deduction benefit is gone, what other option can homeowners turn to if they want to use the equity in their home?
This is an important question because homeowners today have a lot of equity. Black Knight Data & Analytics said that the 42 million homeowners with mortgages had a total of $5.5 trillion in equity that they could tap in the third quarter of last year. That figure is an all-time high.
So if home equity loans are no longer that attractive, how else can owners tap into that equity?
Some might turn to cash-out refinances. Say your home is worth $200,000 and you owe $100,000 on your mortgage. You might decide to refinance that loan for $150,000 instead of $100,000. You could then use the extra $50,000 to pay for anything you want, from a major kitchen remodel to paying off the balance on your credit cards.
There is a downside here. Instead of paying back a new mortgage of $100,000, you'd be paying one of $150,000. You'll have to pay more each month to pay that loan down.
Home equity loans can still work, though
Just because the tax benefits of home equity loans are disappearing, though, doesn’t mean that these loans are no longer a viable option for all homeowners.
The deduction was a benefit, but the biggest advantage of home equity loans is that they are a relatively cheap way to borrow money. The mortgage rates attached to home equity loans tend to be low. That isn’t changing.
So if you do have equity in your home and you want money to help pay, say, for your children’s college tuition, a home equity loan or HELOC might still be a smart move.
"While tax deductions are important, they are not the only reason we take out home equity loans," said David Reiss, professor law at Brooklyn Law School in Brooklyn, New York.
Reiss said that when considering whether a home equity loan or HELOC is right for them, homeowners need to ask several important questions.
First, why do they want to take out the loan? If it's for home improvements or to reduce high-interest-rate debt, the loan might still be worthwhile, even with the tax changes.
Next, homeowners need to look at their monthly budgets to determine if they can afford the payments that come with these loans. Finally, homeowners should consider whether they can borrow money cheaper somewhere else, taking the loss of the deduction into consideration.
"If you are comfortable with your answers, there is no reason not to consider a home equity loan as a financing option," Reiss said.