HELOC and Mortgage Refinancing: Can You Still Deduct the Interest?
The Tax Cuts and Jobs Act (TCJA) of 2017 made significant changes to the tax code, eliminating the interest deduction for Home Equity Lines of Credit (HELOCs). However, there is an exception: the interest on a HELOC is still deductible if the funds are used for home improvement projects.
The TCJA's Impact on HELOC Interest Deduction
Under the TCJA, HELOC interest is no longer deductible in all cases. One of the most significant changes is the removal of the home improvement exception, which previously allowed homeowners to deduct the interest from a HELOC used for improving their home. While the law stated that the exception applies only for home improvement projects, many homeowners mistakenly thought it applied to mortgage refinancing as a form of home improvement.
However, paying off an existing mortgage with a HELOC is generally considered a form of refinancing, not an improvement to the home. According to the TCJA, interest on a HELOC used for refinancing cannot be deducted. This is a gut reaction based on the tax act's intent, even for experienced CPAs like myself, who have been in the field since 1985.
Interest Deduction: Conditions and Considerations
It is important to note that the interest on a HELOC is still deductible if the funds are spent on home improvements. The maximum combined loan amount eligible for interest deduction is $750,000, and this can be a combination of a primary mortgage or a HELOC. However, if you pay off a mortgage with a HELOC, the interest on the Heloc becomes non-deductible as there are no qualifying improvements to the home.
The logic behind this is that refinancing is not considered an improvement to the home. If you do not have a home improvement project in mind, using a HELOC to refinance your mortgage may not provide any tax benefits, and you may instead face higher interest rates and variable rates that could increase in the future.
Variable Rates and Future Considerations
While it is possible to use a HELOC to pay off a mortgage, the rates on a HELOC are usually higher than those on a mortgage, and they are often variable rates that can increase over time. Additionally, HELOC interest is not deductible when used for refinancing, making it a less favorable option. If interest rates start to rise, your payments on the HELOC could skyrocket, leaving you paying more than the interest deduction would provide.
Furthermore, a HELOC is a secured debt, as it is backed by a lien on your home. This means your property is at risk if you are unable to pay back the loan. It is essential to consider all these factors carefully before deciding to use a HELOC to pay off a mortgage.
Conclusion
The TCJA has changed the landscape of mortgage refinancing, leading to a limited interest deduction window for HELOCs. If you want to take advantage of the HELOC interest deduction, ensure that the funds are used for genuine home improvements within the $750,000 limit. Without such improvements, using a HELOC to refinance your mortgage is likely to cost you more in the long run due to higher interest rates and the lack of tax benefits.
Remember that the decision to use a HELOC to pay off your mortgage should be based on careful financial planning and consideration of future interest rate trends. Consulting with a tax professional or financial advisor is highly recommended if you have any doubts or questions.