Now that the Federal Reserve has cut interest rates significantly, many banks have reduced their prime lending rates. This in turn has reduced rates on some consumer and home equity loans.
Unlike the interest on consumer loans, home equity loan interest is tax deductible if certain requirements are met. Thinking of capitalizing on the equity in your home? Here are a few factors to weigh.
The interest you pay on a home equity loan of up to $100,000 ($50,000 if you are married filing separately) which is secured by your home generally qualifies as an itemized deduction. But there are other considerations. To find out whether a home equity loan is your best financing option, compare the effective after-tax interest rate on the home equity loan with the interest rate available on consumer loans. To calculate a home equity loan’s effective after-tax interest rate, subtract your marginal income-tax rate (your tax bracket) from 100% and multiply the result by the home equity loan’s interest rate.
Example. If your marginal income-tax rate is 27.5% and you can secure an 8% home equity loan rate, the effective after-tax interest rate of the loan will be 5.8% (100% - 27.5% = 72.5%; 8% ´ 72.5% = 5.8%). Thus, if the lowest consumer loan interest rate available to you is higher than 5.8%, the home equity loan may be the better choice.
Note that if your adjusted gross income is more than $132,950 ($66,475 if you are married filing separately), your itemized deductions will be limited and you may not be able to deduct some or all of the interest on the home equity loan. There may also be some costs associated with obtaining a home equity loan.
Remember that you will need to pay off the home equity loan when you sell your home. So before you go through the trouble and expense of getting a loan, consider how long you plan to live in your current home. And while home equity loans can be a tax-smart financing option, you should also consider the risks associated with pledging your home as collateral if you become unable to make the loan payments.
For further information on home equity, please contact our Consumer Lending Department at (585)394-4260.