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.

Home equity loan example 1: 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:

Appraised value of home $170,000
Credit limit percentageX 80%
Adjusted appraised value $136,000
Less mortgage debt$120,000
Potential home equity loan $ 16,000

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

Home equity example 2: Assume with the above example that Tanya obtains a $60,000 home equity loan. She will have exceeded the ceiling by $10,000.

Original mortgage $120,000
Home equity loan$ 60,000
Total mortgage debt$180,000
Permissible ceiling
Excess amount $ 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.

High To Loan Value Loan
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.