Home equity loan tax
For most taxpayers, all mortgage interest expenses on the first and second personal residences remain fully deductible in spite of the elimination of the deduction for other personal interest expenses, for example, interest on credit card purchases or personal automobile purchases.
Home mortgage debt must be secured by a security interest perfected under local law on the qualified residence. In addition, the deductible portion of home mortgage interest is limited to the taxpayer s qualified residence interest. That is, the debt, within limits, must be incurred to buy, build, or substantially improve these qualified residences.
Because of the Tax Reform Act of 1986, home equity loans came into vogue. These loans allow the taxpayer to deduct interest on a loan secured by a principal residence, even though it has no relation to the acquisition or substantial improvement of the residence.
A simple method of applying for a loan is that we should have a reason to borrow. Lines of credit are becoming popular today, since many use the equity consumers have in their homes as collateral. Because of this, money borrowed using these credit lines are, by government definition, a Home Mortgage, and thus the interest on the loan is tax deductible.
II. Alternative loan sources:
The first four sources of auto financing are:
Finance companies;
Dealers;
Banks; and
Credit unions.
All the above four sources are widely known and widely used. But the other three sources on the list have the potential to save our money versus these traditional sources. They go largely underutilized today, because relatively few people think to tap into them.
One Alternative method of auto financing gaining popularity these days is the home equity line of credit. There is a simple reason for this surge in the use of home equity loans for car buying the interest we pay on these loans is tax deductible. Once upon a time all interest on consumer debt was tax deductible, but the Feds have tightened the screws in light of the budget deficit.
III. Home equity loan tax:
Depending on tax bracket, saving a considerable amount over the course of the loan can be done. For example, if in the 31% income tax bracket and the home equity loan used to purchase a vehicle has a 10% interest rate, when all is said and done, you pay an effective interest rate of around 7%. Over the course of 4 year loan on $20,000, this will save about $1,350.
Using a home equity loan also has its downsides. If we have already established a home equity line, and required to pay for a property appraisal and a title search to assure the lender that have the equity in our home to borrow against. We must have to pay an origination fee and lender points which essentially, is cash due at the beginning of the loan. We must pay close attention to these fees and charges because they could wipe out any savings might realize because of the tax deductible nature of the interest we will pay.
Another potential pitfall is the fact that some home equity loans carry variable interest rates. Standard auto loans are fixed-rate loans. The financial institution agrees with us on an interest rate, and that is the rate we pay over the life of the loan. In contrast, variable rate fluctuate based on a key interest rate indicator within bounds specified by the loan contract. Because the rates vary, the monthly payments could vary widely as well. This can play havoc with our monthly budget.
Finally, acquiring a home equity loan means we are using the ownership we have in our home as collateral guaranteeing the loan. This has serious implications if we fail to pay off the loan. Looking at it this way, if for one reason or another we cannot pay off a standard car loan, the financial Institution simply repossesses our vehicles. It is not pleasant, but it is simple. In essence, the vehicle itself was the collateral. But if we cannot pay off a home equity loan, our home is, in theory at least, at risk. The lender can put a lien on it, and, depending on the money we owe and our equity in the house, seize it. This is an extremely rate occurrence, but it is something to keep in mind when we borrow against our home to finance our new vehicle.
IV. Interest on mortgage credit certificates:
Under special state and local programs, we may obtain a Mortgage Credit Certificate to finance the purchase of a principal residence or to borrow funds for certain home improvements. Generally, a qualifying principal residence may not cost more than ninety percent of the average area purchase price. 110 % in certain targeted areas. A tax credit for interest paid on the mortgage may be claimed. The credit is computed on Form 8396 and claimed on Line 49 of Form 1040. The credit equals the interest paid multiplied by the certificate rate set by the government authority, but the maximum annual credit is $2,000. If the claim the credit, the home mortgage interest deduction is reduced by the amount of the current year credit claimed on from 8396.
For example, in case we pay $5,000 interest for a mortgage issued under a qualifying Mortgage Credit Certificate, under its terms, we are allowed a tax credit of $750. If the allowable credit exceeds tax liability, a three year carryover is allowed for the excess credit.
If buying a home using a qualifying mortgage credit Certificate and selling that home within nine years, then must recapture part of the tax credit on Form 8828.
V. Home equity loan to pay consumer debts:
Interest on consumer loans is not deductible, but can use a home equity line-of-credit mortgage to pay off existing consumer debts and finance future consumer expenses. However, although interest on a home equity loan is fully deductible for regular tax purposes if within the limit of $100,000 the interest is not deductible for purposes of alternative minimum tax, unless the loan proceeds were used to improve the first or second home.
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