It's a big and confusing question for many homeowners in the wake of the December tax law changes: Are new interest-deductible home equity credit lines (HELOCs) and second mortgages now totally out of reach going forward?
The new law eliminated a long-standing section of the tax code that allowed homeowners to borrow against their equity and use the proceeds for whatever purposes they chose, while deducting interest payments on their federal taxes. That provision of the new tax law took effect Jan. 1, so it's logical to assume that popular tax-deductible HELOCs no longer will be available.
They're dead, right? Not quite! To borrow a phrase from Miracle Max in "The Princess Bride," the traditional uses of HELOCs may be "mostly dead" — but not all dead.
A close reading of the final language rushed through Congress last month reveals that interest-deductible HELOCs and second mortgages should still be available to homeowners provided they qualify on two criteria: they use the proceeds of the loan to make "substantial improvements" to their home, and the combined total of their first mortgage balance and their HELOC or second mortgage does not exceed the new $750,000 limit on mortgage amounts qualified for interest deductions. (The previous ceiling was $1.1 million for the first mortgage and home-equity debt combined.)
"The key here is [how] you use the proceeds" of the HELOC or second mortgage, Ernst & Young tax partner Greg Rosica told me in an interview. You can't buy a car anymore. You can't spend the money on student loans, business investments, vacations or most of the things you used to be able to do. Now, to take deductions on the interest you pay, you've got to limit expenditures to capital improvements on your house, or — less likely — buying or building your principal residence.
The reason, said Rosica, a widely recognized expert on real estate tax law, is that although Section 11043 of the new tax law eliminated home-equity debt interest deductions, it left virtually untouched interest deductions for primary home mortgage debt ("acquisition indebtedness") that is used to buy, improve or construct a new home. As long as you follow the rules on what constitutes a capital improvement — spelled out in IRS Publication 530 — and do not exceed the $750,000 total debt limit, "it is deductible," Rosica said.
Banks and other lenders active in HELOCs and second-mortgage arenas agree with this interpretation and plan to continue offering home-equity products. Bob Davis, executive vice president of the American Bankers Association, told me "HELOCs will still be in the mix," despite widespread concerns that they might disappear after the elimination of the home-equity section of the tax code.
Michael Kinane, head of TD Bank's extensive second-lien product offerings, said in a statement for this column that HELOCs and home-equity loans remain available and popular, whether interest is tax-deductible or not, and can be "the best, lowest cost option for homeowners." In mid-January, TD's rates for owners with solid equity and good credit on a $100,000 HELOC were 3.99 percent APR, about half a percentage point below the prime bank rate.
A survey of HELOCs and second-lien lenders active on the LendingTree.com loan-shopping network conducted for this column found a "consensus" that not only will lenders continue to offer such financing, "but more lenders will offer them as home prices [and] values rise," according to spokeswoman Megan Greuling.
Lenders generally won't advise you on interest deductibility, urging instead that you consult your tax adviser. Also, the final word on interest deductibility will need to come from the IRS. But the attorneys, CPAs and legislative tax experts consulted for this column were unanimous in their belief that the IRS will agree with their interpretation of the law changes.
Bottom line: Despite rampant rumors to the contrary, home-equity-based lending won't be disappearing anytime soon. Borrowers who want to deduct interest will need to restrict their expenditures to qualified home improvements. Others who simply want to tap into their equity they've built up at attractive interest rates and use the money for whatever they choose will be able to obtain HELOCs or second mortgages, just as they did in the past.
And for those owners who now plan to opt for the standard deductions of $12,000 or $24,000, there'll be no issue at all. Since they will no longer be itemizing, no big deal. They won't be thinking about interest deductions anyway.
Ken Harney's email address is Harneycolumn@gmail.com.