If you have ever dropped a glass in the kitchen I’m sure you can remember the way time slows down and the sight of the glass in mid-air casually gliding to its doom is etched in your memory. Seeing broken glass on the floor may lead you to remember the saying, “there’s no use crying over spilled milk.”, but misuse of your HELOC can lead to heartache and tears as government regulations regarding these funds are more stringent.
Sally Herigstad with Realtor.com recently wrote,
“…if you’re not clear on how the new law affects you, you could make some mistakes with your HELOC that could cost you big-time! Once you make these errors, it can be difficult or impossible to undo them. So, it’s crucial that you’re clear on what you can (and can’t) do with a HELOC today.”
Sally Herigstag: 8 Grave Mistakes to Never, Ever Make With Your HELOC; realtor.com; Feb 25, 2020
HELOC is a fancy acronym for Home Equity Line Of Credit which is a secured loan on the equity in your home. Equity is the difference between your mortgage balance and the market value of your home. A loan on this amount is secured by your property. Since an equity line of credit is a “secured” loan, the interest rates are usually lower than a similar amount available on a credit card or a personal loan through a lender that is unsecured by collateral.
Keep Your Receipts
The most important part of a HELOC for most borrowers is the ability to deduct the interest on your annual Federal Tax return. That deduction is limited to items purchased to directly improve your home.
HELOC or Equity Line borrowers used to be able to use the available credit to pay off credit card balances, college tuition, and other expenses that were unrelated to the home and still be able to deduct the interest expenses paid on that equity line for that tax year. Under the new rules adopted in 2017, expenses other than those used to complete major updates or home improvements may not be able to qualify for a tax deduction. You should always check with your tax professional for the real truth about what qualifies, and what will not qualify for those deductions.
When you are taking the tax deduction on your tax return it does open your return to an audit by the IRS. The burden of proof is on you to be able to support all of your deductions if the IRS comes calling during an audit. Making sure you have a file with all your supporting HELOC or Equity Line of Credit documents and receipts will give you peace of mind if you are audited.
Only Spend On The Secured Property
In order to get the most out of your equity line, you should limit expenses against your available credit to those on the property. You may be able to use available funds to pay for whatever you wish (again, check with your lender and your tax professional for the details on your specific situation and loan details), but you may not be able to deduct the interest on your tax return.
Using your equity line as a downpayment on a vacation home may look great at first, but you may not be able to deduct the interest from that purchase or any additional purchases used to decorate or improve that second property.
If you use HELOC funds to purchase an investment property you may be in a good position even though you cannot take the deduction of the interest. When you have tenants in your investment property, their rent or lease payments should be able to cover the property mortgage AND the equity line payment. If the tenant’s gross rent cannot cover your monthly costs, the investment is not a good one. You should have a team of finance, tax, legal, and property management professionals to advise you and help you make the best plan for your goals regarding real estate investments and dealing with tenants. In the end, all agreed to loans and purchases are your responsibility to cover.
Always be aware of over-leveraging your financial situation. You always want to know you can personally make the payments on any and all loans you take out. Correctly using a HELOC for a remodel may possibly help you increase your property value and increase your positive net worth. However, if you don’t look at the big picture in all the credit you have used and owe, and how much you can afford to pay each month (you Debt To Income [DTI] ratio), it is very easy to get upsidedown and overextended to damaging levels very quickly.
The Bottom Line
Being able to increase the value of your home and be able to deduct the interest can mean a lot to your personal finances. Knowing the rules regarding equity lines is important so you don’t get into trouble come tax time. Having a great relationship with a tax and financial advisor will help you get accurate advice and possibly keep you from making mistakes.
Knowing the rules is only one part of the equation. It is probably more important to know your overall financial situation and ability to repay the loan so you don’t get overextended. Taking $30k or $40k to improve your home may not increase the value of your home by that amount. Using $30k in funds will increase your combined monthly payment, but if it overextends your ability to repay you could be placing the whole property in jeopardy of foreclosure and really affect your personal credit score for the negative.
Know the rules, and know your financial picture.
Before you sign the paperwork, discuss all financial considerations with your tax professional and your financial advisor. You can give us a call to discuss how your remodel goals may affect your property value, and to look at all of your options to move your real estate plan forward. We are here to help guide you along your real estate journey and connect you with financial professionals in your area to build your own Real Estate Advisor Team. Call or text us at (503) 799-8354 to discuss your ideas and dreams. We’ll help you along the way.
As always, we’re asking the question, “How can we help you today?” Even if you are not planning a real estate purchase or sale soon, we want to help you in any way with your present situation. Check out our home value analysis for the specific possibilities on your home, and check out our recent Market Update for your area to give you a general look at what’s happening in your city.
We appreciate you looking us up, and letting us be your information source for anything you may have a question on or need help with. We love people, and we love properties. Just reach out and call us at (503) 799-8354 to get answers to your questions.
Cheers,
Michael Jester
Oregon Licensed Real Estate Broker
My Real Estate Advisor Team
(503) 799-8354 cell
(503) 437-9005 office
michaelj@myreateam.com
Bella Casa Real Estate Group
207 NE 19th Street, Suite 100
McMinnville, OR 97128
(503) 437-9005 office
https://thebellacasagroup.com
