4 Tips To Keep Your Home Equity Loan Both Useful And Tax-Deductible

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A home equity loan is a valuable asset in your financial toolbox. And to wield it to its maximum advantage, you should ensure that you can deduct the interest on your income taxes. How can you do this? Here are four simple rules to follow.

1. Use it for Improvements. Under the recently passed tax laws, beginning in 2018 there are some new limits to how you can use a home equity line of credit and still deduct the interest. This limitation is that the money must be used for home improvements. This includes things like a new roof, finishing the basement, adding energy-efficient appliances, or room additions. Unfortunately, you can't use it for a vacation, college expenses, or paying off other debt, though.  

2. Keep it Under the Limit. There is a dollar limit to how much you can deduct, as well. Prior to 2018, you could deduct interest on total house-related loans up to $1,000,000. However, this limit has been lowered to $750,000 ($375,000 for married persons who file separately). Keep your total loans — including a regular mortgage, second home, and all home equity borrowed — under this limit to meet the new rules. 

3. Maintain Good Records. While audits are generally rare these days, you should still keep sufficient records to prove these two things. Records of invoices from and payments to vendors for home improvements can fulfill this need. Place them with your income taxes for the years in which they are claimed. In addition, keep a copy of Form 1098 from your lender showing the amount of mortgage due at the time as well. Make copies for subsequent years' tax records for as long as the loan is being paid off. 

4. Have a Strategic Plan. There are ways to fund other ventures with a home equity loan even staying within these rules. For example, you could use the equity line of credit to pay for a mortgage on a second home that can generate unrestricted income as a rental unit (part-time or full-time). You can also use it as an emergency home savings fund for things like repairs and natural disasters, then use your regular savings to pay for non-deductible expenses like college. 

By planning how you will deploy a home equity loan as a tool in your arsenal, you can help ensure a more solid financial footing for your family's future while still saving money today.