Is Home Equity Deductible?

Home Equity Basics

Interest on a home equity loan is tax deductible. Home equity is the amount of value a homeowner possesses in a property. As home values rise over time, the amount of equity increases. Many homeowners tap into that equity using home equity loans. These loans offer homeowners some financial flexibility for paying for other things with some tax advantages. However, homeowners should carefully weigh the costs and benefits associated with such loans.

Home equity loans can be used to pay off higher-interest debt. For example, a homeowner might have a large credit card balance of $20,000 with a 12 percent interest rate. The homeowner might decide to take out a home equity loan to pay off the credit card. The home equity loan will usually be at a lower interest rate, maybe 6 percent. In addition, the interest paid per year is tax deductible, assuming the homeowner itemizes deductions.

Home equity loans should be used with great caution. Using the loans to pay for depreciating assets such as cars is risky. Each dollar of home equity must be paid back, lengthening most borrowers' time paying off a house. There are some good uses of home equity -- paying for further education often works for homeowners. For example, a homeowner might take a low-interest, tax-deductible home equity loan to pay for law school and move on to a higher-paying career. Another smart use of home equity would be investing in a promising business and becoming an owner or partner.

A home equity loan can be abused. While the interest is tax deductible, there is a risk of losing a home. Many homeowners took home equity loans in the early 2000s, and a few years later the housing market crashed. Many homeowners found that covenants in the home equity loan contracts specified a loan-to-value ratio above the value the new depressed values. Many home equity loans automatically kicked in higher interest rates to make up for the higher risks, damaging the cash flow of the borrowers.