The IRS eliminated the tax deduction provision for interest on most personal loans including auto loans. As with most any change in tax regulations, savvy lenders have figured out a way to get around that restriction, offering a loophole involving your most expensive asset: your home. Borrowing money should always be undertaken carefully, especially when you offer your home as collateral.
Home Equity Loan
If you take out a home equity loan, you can mortgage interest on your federal tax return. These loans are based on a percentage of the equity in your home, with banks limiting the amount of money you can borrow. What banks do not limit is what you do with that money, funds which can be used to make home improvements, repairs, consolidate debt, spend on a vacation or to buy a new car. You can use your home equity loan for one or more purposes.
Tax-Smart Loans
Some lending institutions offer home equity loans by a different name including so-called tax-smart loans. These kinds of loans are used for the purchase of a car and may help you avoid the usual time expended and closing costs paid out with a home equity loan. Under this lending arrangement, the bank knows that you borrowing money to purchase a car and will put a lien on your car and on your house. Compare the interest rate you pay for this kind of loan because it may be higher than the going rate for home equity loans.
Deductions
The IRS allows taxpayers who itemize their tax returns to deduct home mortgage interest on Schedule A. The lenders for your mortgage and for your home equity loan must send you separate Form 1098s, reflecting your total interest paid to them for the year. Add those amounts together and put that total on line 10. You will be adding home interest payments with your other deductions to tabulate your total itemized deductions. That total is reflected on line 29 of Schedule A and transferred to Form 1040, line 40, an amount which can decrease your tax obligation.
Warnings
Taking equity from your home can put your home at risk if you cannot meet payments. The first or primary mortgage and your home equity line or secondary mortgage means that there are two liens on your home. If you default on either loan, then your home can be foreclosed. If your home equity loan is written as a tax-smart loan, you could also lose your car. Contact a tax advisor to determine the best financing option for you.
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