Using the equity you have in your home to secure a loan may be a tax-wise method of financing or refinancing some of your personal and business expenditures. Here are a few home equity-borrowing techniques that may save you tax dollars. Financing Personal Expenditures The interest you pay on consumer purchases, such as personal loans, car loans, and credit card debt is not deductible for federal income-tax purposes. However, interest paid on a home equity loan of up to $100,000 secured by your personal residence generally qualifies as an itemized deduction, even if the loan proceeds are used to pay off your existing consumer loans or to purchase personal items. You should compare the effective after-tax interest rate on the home equity loan to the interest rate on the particular consumer loan you are considering to determine which deal is more favorable. To calculate a home equity loan’s effective after-tax interest rate, subtract your marginal income-tax rate from 100% and multiply the result times the home equity loan’s interest rate. For example, if your marginal income-tax rate is 25% and you can secure a 7% home equity loan rate, the effective after-tax interest rate of the loan will be only 5.25% (100% – 25% = 75%, 7% ´ 75% = 5.25%). Thus, if your consumer loan interest rate is higher than 5.25%, it may be beneficial to take the home equity loan. However, keep in mind that there may be some costs in obtaining a home equity loan. Financing Business Expenses Interest on business loans is fully deductible against business income. A business owner who uses proceeds from a home equity loan for business purposes may elect to treat the loan as a business loan rather than a home equity loan. Making this election has several potential advantages: – You don’t need to itemize to claim the business interest deduction, – For the self-employed, reducing business income also reduces self-employment tax; and – Transferring home equity debt to business debt in effect allows you to write off interest on more than the $100,000 maximum level of home equity indebtedness. Example. The only debts a business owner has on her principal residence are two home equity loans: debt A, with a principal balance of $90,000, whose proceeds were used to buy business equipment; and debt B, with a principal balance of $30,000, and whose proceeds were used to purchase a new car for personal purposes. The aggregate amount of both debts, $120,000, exceeds the $100,000 limit on the amount of allowable home equity indebtedness. However, if the business owner does not treat debt A as home equity indebtedness, the interest on that debt will remain fully deductible as a business expense, and all of the interest on debt B will be deductible as home equity interest. While home equity loans can be an attractive source of financing from a tax viewpoint, there are risks involved with pledging your home as collateral. Before borrowing, consider your personal financial situation and your ability to repay the loan, as well as the outlook for property values in your area.
Using Home Equity Financing
