Home Equity Loan Examples and the Ceiling Rule

A lender will usually set the credit limit on a home equity loan by
taking a percentage, 80% for example, of the appraised value of
the home, reduced by the mortgage balance. 





Example:
Tanya owns a home worth $170,000.  She paid $50,000 in cash as
a down payment and financed the remaining $120,000.  With an
80% credit limit, Tanya might be able to get a $16,000 home equity
mortgage.  This is calculated as follows:
 

The interest on the $16,000 is fully deductible. 

There is a "ceiling rule" on home equity debt you need to be aware
of.  This is especially true if you obtain a "high-to-loan-value"
equity loan.  The amount of debt you owe on your home cannot
exceed the difference between the present balance on the
mortgage you obtained when you acquired your home and the
present fair market value of your home.  This IRS rule can cut your
deduction if you borrow too heavily against your home. 

Example:
Assume with the above example that Tanya obtains a $60,000
home equity loan.  She will have exceeded the ceiling by $10,000.

Since the total mortgage debt exceeds the permissible ceiling by
$10,000, the interest on the $10,000 portion is not deductible.  The
IRS rules prohibit interest deductions on any part of a
mortgage that exceeds the market value of the house.  There are
exceptions to this.  These exceptions can be found in IRS Publication 936.


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