The Short Answer: When Home Equity Loan Interest Is Deductible
Home equity loan interest is deductible only when the borrowed money is used to buy, build, or substantially improve the home that secures the loan. That is the test the tax code applies to debt secured by a residence, and it applies to debt taken out after December 15, 2017. Borrow against your home and spend the money on anything else, and the interest does not qualify.
The three qualifying uses are narrower than many homeowners assume:
- Buy — the funds go toward acquiring the home that secures the loan.
- Build — the funds pay for construction of that home.
- Substantially improve — the funds pay for work that adds value to the home, prolongs its useful life, or adapts it to a new use.
Routine maintenance and repairs, such as repainting a room or patching a leak, generally do not count as substantial improvements, so interest tied to that spending usually fails the test. The IRS describes the home mortgage interest rules in Topic 505.
The Deduction Requires Itemizing
A qualifying use of the money is not enough on its own. Home mortgage interest is an itemized deduction, so it lowers taxable income only when you file Schedule A rather than claiming the standard deduction.
For many households the standard deduction is large enough that itemizing does not pay. If your itemized deductions, which can include mortgage interest, state and local taxes within their own limits, charitable contributions, and qualifying medical expenses, do not add up to more than the standard deduction, the interest deduction changes nothing about what you owe. IRS Topic 456 explains how itemized deductions work.
Two conditions therefore have to line up in the same tax year: a qualifying use of the loan proceeds, and total itemized deductions that exceed the standard deduction. If either one is missing, there is no federal benefit.
Qualifying Uses and Non-Qualifying Uses
The test follows the money rather than the loan product. The IRS looks at how the proceeds were actually spent, so the same home equity loan can produce deductible interest in one year and non-deductible interest after a change in plans.
| How you use the money | Interest deductible? | Why |
|---|---|---|
| Buying the home that secures the loan | Generally yes | Counts as home acquisition debt |
| Building that home | Generally yes | Counts as home acquisition debt |
| Substantial improvement to that home | Generally yes | Adds value, prolongs life, or adapts the home to a new use |
| Paying off credit card balances | Generally no | A personal expense with no connection to the home |
| Covering tuition, medical bills, or everyday costs | Generally no | Personal expenses unrelated to the home |
| Buying, building, or substantially improving a second home you use | May qualify | Acquisition debt, subject to the overall limit and the one-extra-home rule |
| Renovating a property you rent out | Different rules | Usually treated as investment or business interest |
Interest on debt used to buy, build, or substantially improve a second home can qualify as home acquisition debt, but the overall acquisition debt limit covers your homes together, and the rules generally allow that treatment for only one home beyond your main residence. Interest on debt secured by a property you rent out usually follows investment interest rules instead.
When only part of the money went to a qualifying purpose, the interest is generally allocated between the qualifying and non-qualifying portions. A written record of disbursements is far more useful than a general memory of what the loan was for.
Home Equity Loans, HELOCs, Second Mortgages, and Cash-Out Refinances
The name on the paperwork does not decide the tax treatment. A home equity loan, a home equity line of credit, and a second mortgage are all secured by your home, and each is measured against the same question: what did the money pay for?
A cash-out refinance is analyzed differently because it does two things at once. The portion that pays off the existing mortgage on the home replaces acquisition debt, and interest on that portion can qualify. The extra cash the borrower receives is home equity debt, and its interest is deductible only to the extent that cash was used for a qualifying purpose on the same home. A rate-and-term refinance, which does not put extra cash in the borrower's hands, simply replaces existing debt. Second mortgages and lines of credit are tested the same way as any other home-secured borrowing.
A reverse mortgage works differently again and follows its own set of rules; it is not a route to a home mortgage interest deduction.
The Home Acquisition Debt Limit
Even a fully qualifying use is subject to a ceiling. The tax code caps how much home acquisition debt can generate deductible interest, and the cap for debt taken out after December 15, 2017 is lower than the one that applied to older debt. The limit covers your combined home acquisition debt, includes loans secured by a main home and one second home, and differs by filing status. IRS Topic 505 sets out the current figures and the definitions that go with them.
When qualifying debt sits above the limit, only a proportional share of the interest is treated as deductible. If three quarters of your acquisition debt falls under the cap, roughly three quarters of the interest can be considered. CFPB mortgage resources explain how home-secured credit works alongside these tax rules.
Records That Support the Deduction
The lender reports the interest you paid on Form 1098, but that form says nothing about how you used the money. That part of the story is yours to document, and it is the part the deduction depends on. Records worth keeping include:
- The Closing Disclosure and promissory note, which show the loan amount and that the loan is secured by your home.
- Disbursement records showing where the proceeds went.
- Contractor invoices, contracts, and permits for improvement work.
- An itemized description of what each improvement actually changed.
- A written note explaining any portion of the loan that replaced existing mortgage debt.
- Year-end statements and Form 1098 from the lender showing interest paid.
Store these documents with the tax return for the year you claim the deduction. A deduction that cannot be explained later is difficult to defend.
The Risk Side of Borrowing Against Your Home
A home equity loan is secured by your house. If you stop paying, the lender can foreclose, and the consequence is losing a place to live rather than a mark on a credit report. That risk does not shrink because the interest might be deductible.
Using a home equity loan to consolidate credit card debt converts unsecured debt into debt secured by your home, and as noted above the interest on that kind of consolidation generally does not qualify for the deduction. The FTC guidance on loans and mortgages describes how these products work and what to watch for in the paperwork.
A tax deduction reduces the effective cost of borrowing, but it does not make a loan inexpensive. The interest rate, closing costs, repayment term, and the possibility of falling home values all matter more than the deduction for most borrowers. The CFPB home ownership resources are a useful starting point when comparing offers.
Steps to Check Before You Count on the Deduction
Work through these steps before you assume a home equity loan will produce a tax benefit:
- Write down exactly what the money will pay for, and keep the list current as plans change.
- Check each use against the buy, build, or substantially improve test.
- Estimate whether your itemized deductions will exceed the standard deduction for the year.
- Add up the acquisition debt on every home you own and compare it with the limit that applies to you.
- Compare offers from more than one lender and read the Loan Estimate. Under the Truth in Lending Act, you receive disclosures showing the APR and other terms before you sign.
- Run the numbers with a home equity loan calculator and check your loan-to-value ratio to see how much borrowing the home can support.
Review the closing costs as part of that comparison, since they raise the real cost of the loan even when the interest is deductible. When the tax answer is unclear for your situation, a tax professional can review the specific facts.