Article Highlights:

  • Consumer Debt
  • Home Equity Debt
  • Convert Consumer Debt into Home Equity Debt
  • Conversion Considerations

The only interest that is still deductible as an itemized deduction is home mortgage interest and investment interest. If you are like so many others with large consumer debt, such as credit cards and car payments, you are paying high interest rates that are not deductible. If the amount of consumer interest you pay each year is substantial and you itemize your deductions, you may want to consider converting that nondeductible interest into tax-deductible interest by paying off the consumer debt with a home equity line of credit. Generally, current law allows individual taxpayers to borrow up to $100,000 of home equity and deduct the interest on that loan as home mortgage interest. This would also apply to planned large consumer purchases, such as a car or motor home. Using a home equity line to purchase these items will make the interest deductible.

However, using the equity in your home for frivolous purposes is not financially prudent. Before borrowing against your home, you should carefully consider the following:

  1. Treat any home equity loan or line of credit like a consumer loan and pay it off over the same period of time you would have had to pay the consumer loan. Otherwise, you may reach retirement age without having your home paid for.
  2. When buying a car, you can sometimes get very favorable interest rates or a rebate. It is good practice to make sure that the benefit of making the interest deductible is greater than the benefit of the low-interest consumer loan.
  3. If you have accumulated substantial credit card debt and the high interest rates that go along with it, paying off the credit card debt with a home equity loan or line of credit will substantially reduce the interest charges and allow more of your monthly payments to go toward the debt principal. Using this technique can reduce your non-deductible interest and increase your tax deductions, and thereby reduce your income tax and help you pay off consumer debt more quickly. However, don’t fall into the financial trap of paying off the consumer debt with home equity and then turning around and running up the consumer debt again and repeating the cycle over and over again.
  4. Home equity debt interest is not deductible for alternative minimum tax (AMT) purposes. So, if you are subject to the AMT, this technique generally will not benefit you.
  5. Be aware that the repercussions of defaulting on a home loan are far more serious than on consumer debt.

Please call this office if you have any questions related to using home equity debt to pay off consumer debt and the tax consequences that apply to your particular circumstances.

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