Much has been written about the new tax bill as Americans try to figure out how their personal situation may be affected this tax year. Many people even made last minute changes in 2017 knowing that they would lose some tax benefits as we entered 2018. One change that we haven’t seen a lot of coverage on is the removal of the ability to deduct interest on home equity lines of credit or HELOCs. The exception is when the proceeds are used towards improving the primary residence.
HELOCs are used for homeowners to fund a wide variety of purchases. It is a way for homeowners to take advantage of the equity of their home and is especially attractive to some as we have seen a run up of home prices across the US. Since a HELOC is backed by an asset, interest rates are typically lower than an unsecured loan, such as the ones offered by LendingClub and Prosper. There was an added benefit to a HELOC with the ability to deduct the interest, something that differentiated HELOCs from pretty much all other loan products. Now that this benefit is, in many cases, removed with the new tax code, we may see homeowners opt for other loan types. It is important to remember that the interest deduction only benefited individuals who itemize their deductions, which tend to include individuals with higher incomes.
While HELOCs offer and likely will continue to offer favorable interest rates compared to other unsecured personal loans, there are also other fees to take into consideration. Often the bank charges closing costs on the HELOC which usually includes an appraisal. In addition, some HELOCs are variable rates and that may give pause to some consumers as we potentially enter an increasing rate environment.
Unsecured Lenders May Benefit
As the deduction benefit is removed, other options which offer a pleasant user experience look even better. Platforms like Goldman Sachs’ Marcus charge no origination fee and currently offer fixed rates as low as 6.99% for the best borrowers. Another player in the unsecured consumer lending space called LightStream offers loans as low as 2.49% depending on the use of proceeds. This could lead to the very best borrowers moving to products offered by these companies while borrowers with a less than perfect credit history, who would qualify for a higher rate, may rely on HELOCs.
We will have to wait and see to see how the new tax law affects the use of HELOCs going forward. If the amount of homeowners leveraging this product continues to decline, it will be a continuation of a trend we’ve seen since the financial crisis. If you currently have a HELOC and will no longer be able to deduct the interest in 2018 it may make sense to pay it off.
Note: If you’re looking to learn the intricacies on whether a HELOC is deductible or not as well as a thorough review of other aspects of the Tax Cuts and Jobs Act of 2017, I highly recommend this blog post from Michael Kitces.