How a HELOC can help with this tax season
A home equity line of credit, or HELOC, is a type of home equity loan secured by the equity you have built up in your home. A HELOC can be a powerful tool when it comes to reaching your financial goals.
With tax season in full swing, many homeowners wonder how a HELOC can help them with the current tax season, the fiscal year 2022. If you borrowed prior to January 1st, 2023, you may be able to use available tax deductions to reduce your overall tax bill. If you owe more money to the IRS this year than you are able to pay, a HELOC is a smart alternative to IRS installment plans or credit cards due to low, fixed interest rates and payment flexibility. A HELOC can also be an invaluable tool to consolidate debt and save you money in the long term.
Key Takeaways on how a HELOC can help with your taxes:
A home equity line of credit (HELOC) can be used as an alternative to credit cards or installment plans to pay off taxes
Home equity lines of credit have significantly lower interest rates and more flexibility than other common means of paying owed taxes
A HELOC can be approved and funded in as little 5 days with online lenders (https://www.figure.com/home-equity-line/)
Interest payments on a HELOC can be deducted from this year’s taxes if obtained prior to January 1, 2023, and used for home renovations or improvements
A HELOC can be a valuable financial tool to consolidate debt, leading to greater financial freedom
Tax deductions for interest on a home equity line of credit (HELOC)
The current tax deductions for home equity loans and lines of credit were laid out in the 2017 Tax Cuts and Jobs Act (TCJA). This bill significantly changed HELOC interest-payment tax deductions, so that only interest on HELOCs used to “buy, build, or make substantial home improvements” can be deducted from your annual taxes.
Previously, all interest payments on home equity loans and lines of credit could be deducted on loans up to $1 million. Now the cap is at loans up to $750,000 for couples filing jointly, or $325,000 for individual filers. Deductions are limited to home improvements, renovations, and remodels.
If you have a HELOC that you borrowed before January 1 of 2023, you can deduct the interest on any portion of the loan used toward home improvements, renovations, remodels, and upgrades. Just be sure that you have receipts to document this in case the IRS has any questions.
Use a HELOC to pay off tax debt to the IRS
Even if you can’t use a HELOC to lower this year’s tax burden, a HELOC is often a wise choice if you have a large tax debt that you are unable to pay in full. This is due to the low interest rate you can access compared with other sources of financing.
The most common options people turn to when paying a large tax bill when they don’t have the cash are IRS installment plans and credit cards.
The IRS offers to types of installment plans: short-term (less than 180 days) and long-term (more the 180 days). Regardless of the type of agreement you come to with the IRS, there will be late penalties and interest added to your overall bill. Currently, the IRS charges interest daily at the rate of 7% daily. In addition, you will be charged a .5% monthly late penalty (https://www.irs.gov/payments/quarterly-interest-rates#2023).
At the same time, using a credit card or personal loan doesn’t offer a financial benefit when it comes to paying tax debt. The average US credit card interest rates are over 20% and average personal loan interest rates are over 12%.
In comparison, a HELOC, or home equity line of credit, usually comes with an interest rate closer to 7% and more payment schedule and loan term flexibility. In order to qualify for a HELOC you need to have built up some equity in your home (that is, you owe less money on your current mortgage(s) than your home is worth) and have a reasonable income-to-debt ratio.
Home equity loans and home equity lines of credit are secured by your home, so it’s crucial to make sure you will be able to make your monthly payments if taking this route to pay your tax debt. Otherwise, you could risk foreclosing on your home.