Home Equity Debt
Home equity is the current market value of a home less the outstanding mortgage balance. It is essentially the amount of ownership that has been built up by the holder of the mortgage through payments and appreciation of the property.
If you took out a loan for reasons other than to buy, build, or substantially improve your home, it may qualify as home equity debt. In addition, debt you incurred to buy, build, or substantially improve your home, to the extent it is more than the home acquisition debt limit, may qualify as home equity debt.
Home Equity Debt Definition
Home equity debt is defined by the IRS as a loan that you take out for reasons other than to buy, build or substantially improve your home. To qualify as home equity debt, your mortgage must have been taken out after after October 13, 1987 and meet both of the following requirements:
- 1. Does not qualify as home acquisition debt or as grandfathered debt.
- 2. Is secured by your qualified home.
Home Equity Debt Example 1: Kevin Laird purchased his home for cash in 1995. He did not have a mortgage on his home until last year, when he took out a $30,000 loan, secured by his home to pay for his son Joshua’s college tuition. This loan is home equity debt.
Home Equity Debt Limit
There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your main home and second home is limited to the smaller of:
- 1. $100,000 ($50,000 if married filing separately)
- 2. The total of each home’s fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.
Home Equity Debt Example 2: Doug owns a home that he bought in 1997. It’s fair market value is $120,000, and the current balance on the original mortgage (home acquisition debt) is $105,000. Wells Fargo offers Doug a home mortgage loan of 125% of the FMV of the home less any outstanding mortgages or other liens. Doug decides to take out a home mortgage loan of $45,000 [(125% x $120,000) – $105,000] with Wells Fargo. Doug’s home equity debt is limited to $15,000. This is the smaller of:
- 1. $100,000, the maximum limit, or
- 2. $15,000, the amount that the FMV of $120,000 exceeds the amount of home acquisition debt of $105,000.
The interest on $15,000 of the home equity debt is fully deductible. The interest on the remaining balance of $30,000 is generally treated as personal interest and is not deductible. The interest may be deductible if the proceeds of the loan were used for investment, business, or other deductible purposes.
Debt Higher than limit. Interest on amounts over the home equity debt limit generally is treated as personal interest and is not deductible. But if the proceeds of the loan were used for investment, business, or other deductible purposes, the interest may be deductible.