Are Home Equity Loans Tax Deductible?

Homeownership is expensive, and if you want to improve the home you’re in now, you might need a little help from the bank. If you need cash for home improvement projects, you may be able to access the equity in your home through a home equity loan or home equity line of credit (HELOC).

For years, lenders promoted home equity loans as a smart way to finance home repairs and other expenses. After all, interest rates on home equity loans and lines of credit were low, and the interest was usually tax deductible.

However, that decision hasn’t been as cut and dry since the Tax Cuts and Jobs Act changed the rules for deducting home equity debt.

How Home Equity Loans Work

A home equity loan is a type of loan in which the borrower uses their home’s equity as collateral. The amount you can borrow under a home equity loan depends on the value of the property and your existing loan balance.

To receive a home equity loan, most lenders require your combined loan-to-value (CLTV) ratio to be no more than 85%. For example, let’s say your home is worth $500,000. If your mortgage is paid off, this means you could borrow no more than $425,000. However, if you have a mortgage balance, that’ll factor into how much you can borrow. In this scenario, you’d be able to take out a home equity loan of up to $100,000 with a $325,000 mortgage balance.

HELOCs are similar in that they use your home’s equity as collateral, but rather than a term loan, HELOCs function as a revolving line of credit, much like a credit card. HELOC lenders approve you for a specific credit limit, and you can borrow up to that limit as needed. You’ll have a number of years to borrow from the HELOC—known as the draw period—before you enter the repayment period and have to pay back the outstanding balance.

You can use home equity loans and HELOCs for various purposes, such as financing home renovations or additions, paying for education, starting a business and paying off other high-interest debts. However, if you fall behind on payments or default, your lender can repossess your home since it serves as collateral.

Rules for Home Equity Loan Tax Deductions

A couple of factors determine whether you can deduct the interest paid on your home equity loan. It depends on how much mortgage debt you have and how you used the loan proceeds.

Let’s look at each of those factors in more detail.

Mortgage Interest Tax Deduction Limit

For tax years 2018 to 2025, you can only deduct interest on mortgages up to $750,000. That cap includes your existing mortgage balance, one vacation or second home and any deductible home equity debt.

For example, say the balance on your existing home mortgage is $750,000. Since you’re already at the cap, you cannot deduct any interest on a home equity loan.

Prior to the TCJA, you could deduct up to $1 million in home mortgage debt plus $100,000 in home equity debt.

Use of Home Equity Loan Proceeds

The Tax Cuts and Jobs Act eliminated the deduction for home equity indebtedness. However, the IRS makes an exception if the loan proceeds were used to “buy, build or substantially improve” the home that secures the loan.

For instance, say you take out a $100,000 home equity loan to build an addition to your home. The interest on the home equity loan would be deductible, assuming your total loan balance on both your first mortgage and this home equity loan is no more than $750,000

However, the interest would not be deductible if you borrowed $10,000 to pay off high-interest credit card debt.

How To Deduct Your Home Equity Loan

Suppose your home equity loan meets the eligibility guidelines outlined above. In that case, you must overcome one more hurdle to deduct your home equity loan interest: itemizing deductions.

When you file your federal income tax return, you generally have two options: You can claim the standard deduction or itemize.

However, nearly 90% of taxpayers claim the standard deduction because the Tax Cuts and Jobs Act nearly doubled the standard deduction for all filing statuses.

For 2022 tax returns (those filed in 2023), the available standard deductions are:

• $12,950 for single filers and married individuals filing separately
• $25,900 for married couples filing a joint return
• $19,400 for heads of household

To benefit from deducting home equity loan interest, your total itemized deductions, including that interest, must be more than the standard deduction available for your filing status.

Let’s say you’re a single filer and you paid $4,000 in interest on your first mortgage, $2,000 in interest on a home equity loan to remodel your kitchen, $5,000 in state and local taxes and $500 in charitable donations. Your combined itemized deductions are only $11,500. That’s less than your available standard deduction of $12,950, so there’s no advantage to itemizing.

However, say your total itemized deductions are more than your standard deduction. In that case, you can deduct your home equity loan interest on line 8 of Schedule A (Form 1040).

At the end of the year, you should receive a Form 1098 from your mortgage lender showing how much interest you paid during the year. Keep this form with your tax records, along with any receipts or other documents showing you used the funds to buy, build or substantially improve the home.

Can I Get a Home Equity Loan Without a Tax Return?

Most home equity lenders require a copy of your most recent two years of federal income tax returns. They use your tax return to help verify your income and ensure you can afford to repay the loan.

However, it may be possible to get a home equity loan or HELOC without a tax return, depending on the lender’s requirements and your situation. These are called no-documentation or “no-doc” loans, and they’re often harder to qualify for than a traditional loan.

Don’t let the name mislead you—even no-doc loans require some documentation. However, the lender may use other means to verify your income, such as bank statements, W-2s and financial statements. They may also require a higher down payment and an excellent credit score and charge a higher interest rate.