Written by Gary Moukhtarian
Thinking of tapping into the equity in your home for ready cash and tax deductions? Bear in mind: The 2017 Tax Cuts and Jobs Act eliminated deductions for mortgage interest on home equity loans—unless you’re using the money for “substantial” home improvements.
In other words, you can no longer plan on tax deductions if you use the loan to consolidate debts, to fund college tuition, or to finance a vacation.
You can, however, typically get deductions for remodeling a kitchen or bathroom; adding energy-saving features such as a new roof, windows or boiler; or creating an in-law apartment for those relatives who come for the holidays and decide to stay forever.
Year-end is often when homeowners tap their equity to get those home improvements done in time for the big family celebrations. But it’s important to understand your home equity options—especially new ones you may not know about.
HELOC vs. Home Equity Loan: Which One When?
Simply put, a Home Equity Line of Credit (HELOC) lets you draw funds as needed for a specific time period. You only pay interest on the amount you actually use—usually at a variable rate. The money you don’t use remains available for future needs.
On the other hand, a home equity loan gives you access to a lump sum for a set time period, and you pay a fixed rate. If qualified, the borrower can elect a fixed term of 5, 10, 15, 20, 25 or 30 years, based on principal and interest. In a rising Prime environment, that fixed rate is a reassuring feature.
When should you consider one versus the other? That’s a question requiring input from your tax advisor and your banker, but here are some basic notions:
If you’re not planning to stay in your home long-term—if you anticipate a job transfer in a year or two, for example—then a HELOC may make more sense. You can upgrade your home, increasing its equity, in time to sell it and move—without locking yourself into the long-term commitment of a home equity loan. The HELOC remains payable in full upon the sale of the home.
One caution if you’re in that category: Don’t over-improve your home. The $25,000 you put into your kitchen won’t translate to an equal increase in your home’s equity.
If you love your home and want to remain there, then a home equity loan may give you more stability long-term. In the current seller’s market, I’ve observed that more people are staying put.
This solution is often best for people in retirement, remodeling with adaptive features so they can age in place. Usually the equity in their homes is their biggest asset. Consult your financial advisors to determine your level of loan-to-value risk.
Did you know? There’s a new way to finance remodeling
Webster Bank has introduced an innovative option that lets you borrow against the improved value of your home—before you make the improvements. It’s the Construction Second program.
While a traditional HELOC bases your equity on the home’s current market value, the Webster Construction Second loan takes a different approach: it combines a construction loan with an equity line of credit, letting you borrow up to 80 percent of the improved value your home will have.
In other words, you have access to the funds you need before the contractor begins work—and the contractor only gets paid as the phases of the project are completed, inspected and approved.
What’s more, consumers would pay interest only on the amount drawn during the construction phase. Once construction is completed, the loan will automatically turn into a fully amortized fixed rate for a 15, 25 or 30-year term.
Good news for consumers about home equity borrowing
The mantra today is: know before you owe. With any loan comes risk, so it’s crucial to meet with your banker and other financial advisors before making any decision about using one of your most valuable assets.
However, the entire lending industry is undergoing a transformation: a push for greater consumer knowledge. After the mortgage meltdown of the last decade, new legislation enforces higher accountability for lenders.
During the great recession, Webster Bank was one of the few lenders that reached out proactively to customers to help them stay in their homes, modifying their terms to provide a lower rate and/or payment.
The Bureau of Consumer Financial Protection—the federal agency that helps ensure fair lending—has a website that can help you get clear answers to the complexities you may encounter.
The best solution is always a conversation with a Mortgage Banking Officer, who can drill down deeper into your situation, evaluate your needs and guide you to the right solutions.
The opinions and views in this blog post are those of the authors, and are not intended to provide specific advice or recommendations for any individual. Please consult your tax advisor regarding your individual situation. All loans and lines of credit are subject to credit approval. The Webster symbol is a registered trademark in the U.S. Webster Bank, N.A. Member FDIC.
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