by Michelle Singletary of the Washington Post
The hullabaloo involving President Trump’s personal attorney Michael Cohen is a good time to remind you of a key change in the tax deductibility of home-equity loans. Cohen has said that he tapped his own home’s equity to facilitate the $130,000 payment in 2016 to adult film star Stormy Daniels, who says she had a sexual relationship with Trump a decade earlier. Let’s put aside the politics and possible legal ramifications of Cohen’s actions. It was a foolish financial move by any measure. I hardly think any financial expert would have advised Cohen to use his home’s equity for such an expense. And if we are to believe Cohen, he did so without Trump’s knowledge. Cohen has claimed there were no promises from Trump or the Trump Organization that he was going to be reimbursed the $130,000. If I were Cohen’s financial adviser, I’d slap him silly. The fact that he took out a loan says to me that he didn’t have the cash to make the payment. And if that’s the case, why would he put his own personal finances on the line?
His move is a lesson in how not to use home equity. Under the tax law that went into effect this year, from 2018 until the end of 2025, homeowners who itemize can deduct interest paid on home-equity loans and lines of credit only if the money is used to buy, build or substantially improve the home that secures the loan. Under the old provision, you could deduct the interest on home-equity loans up to $100,000 pretty much without restrictions on what you did with the money. But beginning this year, there’s just one cap on which to base the mortgage-interest deduction. Taxpayers may only deduct interest on $750,000 for qualified residence loans taken out after Dec. 15, 2017. The limit is $375,000 for a married person filing a separate return. The new limits apply to the combined amount of loans, including home-equity debt, used to buy, build or substantially improve the taxpayer’s main home and second home, according to the IRS. There is no longer the separate $100,000 cap specifically for home-equity loans. So now if you use the money for personal expenses to reduce credit card or student loan balances or, say, buy the silence of someone claiming to have had an affair with Trump, you can’t deduct the interest.
Initially after the passing of the new tax law, many people thought that the interest paid for home-equity debt wasn’t deductible under any circumstances. In response to many questions from taxpayers and tax professionals, the IRS issued an advisory to clear up the confusion. As long as the home is used to secure the loan, taxpayers can still deduct interest paid on the mortgage — for a main home or second home — and home-equity loan or line of credit.
But, bringing this issue back to regular folks not under investigation, many experts warn homeowners against taking on this type of debt to purchase a car or put toward credit cards. And I purposely didn’t write “pay off” because when you use a home-equity loan to get rid of credit card balances, you aren’t actually getting out of the debt. You’re just exchanging one burden for another. In my experience, many people who get a home-equity loan tell themselves it’s a good thing to exchange high-interest credit card debt for a lower cost home loan or line of credit. Except with zero balances on the cards, many of these folks end up running them right back up.
As the economy has improved, homeowners are again looking to tap the equity built up in their homes. Owners’ equity in real estate was more than $14.4 trillion in the fourth quarter of 2017, up from about $6.2 trillion for the same period in 2010, according to the Federal Reserve Bank of St. Louis. From the fourth quarter of 2016 to the same period last year, U.S. homeowners with mortgages saw their equity increase 12.2 percent, according to CoreLogic, a provider of property data. Some folks justify getting a home-equity loan for personal expenses by arguing that at least the interest is tax deductible. But with this tax break gone, it makes even less financial sense to borrow against your home unless you need to make a home improvement. If you don’t have savings, and you’re deciding between your roof caving in or getting a home-equity loan, take out the loan. I think it was a good move to limit the deductibility of home-equity loans. Perhaps it will give more people pause before treating their home as a cash cow.