If you have been looking into financing your home remodel, chances are you have heard about a Home Equity Line of Credit. This is also referred to as a HELOC.
This is the equity you have built up over the years of living in your home. Home values rise, as does the equity tied to your home.
What is the best way to go about utilizing this credit available to homeowners? And what mistakes should you avoid?
Read further on the top mistakes you should be aware of when taking out a Home Equity Line of Credit.
Mistake #1: Not understanding how a HELOC works
The way this credit option works is the homeowner uses their equity as collateral to borrow the funding. This interest-only loan works very similarly to a credit card and you just pay the interest as you go.
Many homeowners do not know that the interest automatically kicks in as soon as the funds are used. A HELOC is best used for long-term projects. This is because you can take out the funds as needed instead of in full. Repayment options can be flexible as well as the option for variable interest rates.
Curious about other home improvement loan options? Check out the pros and cons of some popular loans here.
Mistake #2: Deducting too much interest
While you can deduct interest on qualifying HELOC purchases, the IRS has a limit as to how much you can deduct.
Here are those limits, according to Realtor.com:
- $100,000 home equity loan or line of credit limit: You can deduct interest on only up to $100,000 of home equity debt. If you have a home equity line of credit balance of more than $100,000, you can deduct interest only on $100,000 of that debt.
- $750,000 cap on total mortgage debt: You can generally deduct interest only on your first $750,000 of mortgage debt, including first mortgages and HELOCs. The cap is higher—$1 million—if you obtained the qualifying mortgage debt and HELOCs before Dec. 15, 2017.
- Total debt limit based on the purchase price of the home: In addition to the above caps, you can deduct interest only on your total home mortgage debt. That includes your first mortgage and any HELOC, up to the total amount you paid for your home. So, if you paid $250,000 for your home and took out a $25,000 HELOC, you can deduct the interest on only up to $275,000.
Mistake #3: Using your HELOC for other purposes
With all of this credit available to you, it can be tempting to pay off other expenses and debt with your HELOC.
You may be able to deduct a portion of the interest on your HELCO come tax season, but things can get tricky.
Tax laws are getting stricter, and you may need to show proof of qualifying purchases. That does not mean you can’t use your HELOC for non-home improvement-related expenses, you just may not be able to deduct interest on those purchases.
In which case, it may make more sense to take out a separate loan or line of credit for non-home-related expenses in order to keep your finances more organized.