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Will the IRS care about my home equity loan?

I see offers all the time now about using the equity in my house to pay off credit card debt. Some say I can borrow 125 percent of the value of my home. Are there any potential problems with this? Does the IRS care?

ANSWER:

The loans you refer to are called "high loan to value" financing, or high-LTV. These loans really did not exist a few years ago and are now a $12 billion per year business.

The way they work is fairly simple. A homeowner may have a $50,000 loan on a $57,500 house or condo. He may also have $12,500 in non-deductible credit card or auto debt that may have high interest rates. He could apply for a second mortgage, a high-LTV, of $20,000. His idea, of course, is to make the interest deductible.

Under federal tax rules, mortgage interest deductions are limited to interest on loan amounts up to the market value of the home when the loan was closed. This means that a homeowner who is writing off the full interest on a high-LTV mortgage is incorrect. This homeowner may be misinformed about the federal law that limits interest deductions, or he may have been misled by a loan broker.

The Internal Revenue Service certainly cares about this mortgage product. There is a plan to create a new method for identifying homeowners who have mortgages that exceed their homes’ values. There will be a revised Form 1098 which is the mortgage interest statement that all mortgage lenders must send each year to each home loan borrower. A copy of this must also be sent to the IRS.

The revised form includes a new box for lenders to check if they believe a borrower has a high-LTV loan. This enables tax auditors to electronically cross-check interest deductions.

It is best to obtain the help of a professional tax advisor when making decisions that involve tax law, especially since some of the interest for the second mortgage is probably deductible.

This information is not intended as specific legal advice to anyone and is based upon facts that change from time to time. Individuals should seek legal counsel before acting upon any matter involving the law.

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