Many Americans who use their homes as ATMs are about to get hit with a sizable withdrawal fee.
The tax law signed last week by President Trump suspends the deduction on interest for home equity loans and lines of credit, ending a longstanding perk of homeownership.
Under the old law, homeowners who took out a second loan of up to $100,000 could deduct the interest from their taxes. That provided an incentive for consumers to use home equity products — instead of other types of loans — to finance everything from car purchases to higher education to the consolidation of credit card debt.
The new law suspends that favorable tax treatment between 2018 and 2025. The change applies not only to homeowners who take out new home equity loans, but also those who already have them.
Experts predict that the revised law will reduce the demand for home equity loans and lines of credit in certain customer segments — in particular, folks who itemize their deductions and have other borrowing options.
“I think at the margin it makes you less likely to do a home equity line of credit,” said Laurie Goodman, co-director of the Housing Finance Policy Center at the Urban Institute.
But that line of thinking is far from universal. A recent blog post from Raddon indicates as many as 28 percent of consumers expect to take out some kind of home equity loan product within the next 12 months.
How will demand for loan products change?
What the new law means for lenders is less clear. Demand for home equity loans has declined sharply since peaking in 2009 and could slow even more now that the tax break has been suspended, many say.
But some experts say that any decline in home equity balances could be offset by higher demand for auto, credit card and other consumer loans. The worry is that only borrowers with blemished credit will take out home equity loans, increasing the risk to banks.
Lawyers and banking industry trade groups are still analyzing the legislative language in an effort to understand its full implications. But some observers believe that the new law also suspends the deductibility of interest on equity that homeowners extract from their houses in so-called cash-out refinances.
“The compromise legislation preserves the mortgage interest deduction with some modifications. For homeowners with existing mortgages, there would be no change to their mortgage interest deduction,” according to a tax bill analysis white paper from the Credit Union National Association. “Unfortunately, the compromise bill would eliminate the deduction for interest on home equity loans. However, similar to the mortgage interest deduction, this provision would be modified in 2026 to allow for the deduction of home equity debt.”
The language around HELOCs in the bill may not be what it seems, according to Carrie Hunt, executive vice president of government affairs and general counsel at the National Association of Federally-Insured Credit Unions.
“There seems to be a lot of confusion out relative whether or not the deduction related to home equity was completely eliminated or not,” Hunt said. “I know that some initial analyses out there seemed to indicate that it was but the way that we read it if there still a major home improvement projects, like what home equities were really designed to do then that interest is still deductible.” The tax bill, Hunt argues, is trying to avoid people using HELOCs to buy luxury items unrelated to home improvement.
The Mortgage Bankers Association and the American Bankers Association declined to comment.
Cash-out refinances have been a popular way for Americans to access their home equity during an era of low interest rates, allowing folks to refinance their existing debt at a cheaper rate and pocket the savings.
Meanwhile, home equity products have been expected to grow in popularity as interest rates rise, since they will enable home owners to retain a low interest rate on most of their mortgage debt.
How the new tax law affects consumer decision-making will depend heavily on individual circumstances.
Only taxpayers who itemize their deductions will be hit with larger tax bills as a result of the change in the treatment of home equity loans. Those are often folks who have relatively high incomes and other viable borrowing options. In the past they may have used their home equity to pay for unrelated purchases, but they might choose another option under the new tax rules.
“Years ago I remember using a home equity loan to purchase my new car because I could get a better rate and a lower payment,” Joe Tyrell, executive vice president of corporate strategy at the mortgage tech company Ellie Mae, recalled in an email. “I was also able to deduct the interest.”
Tyrell expects fewer Americans to go that route under the new tax law. “The prevailing belief is that instead, they can negotiate a better deal with the car dealer,” he said.
For many less creditworthy homeowners, home equity loans are likely to remain the most economical way to gain liquidity. That’s because for individuals with tarnished credit records, the interest rate on an auto loan or a personal loan is likely to be substantially higher than the rate on a home equity loan.
Still, the inability to write off the interest on those loans could wind up hurting those borrowers, said Sean Fox, co-president of the debt resolution firm Freedom Financial.
“Many folks are running at the edge,” he said. “Small changes in their situation can really matter.”
Edward Pinto, co-director of the Center on Housing Markets and Finance at the American Enterprise Institute, is a longtime critic of government subsidies for homeownership, and he supports the new tax law’s treatment of home equity loans.
But Pinto also warned that the law may increase the level of credit risk for home equity lenders, since better qualified borrowers will turn to other products. The creditworthiness of home equity borrowers will become a larger issue if housing prices drop again, as they did a decade ago.
“As we know, that equity could be real or illusory,” Pinto said.
After the 2008-9 financial crisis, the use of home equity products dropped substantially, in part because homeowners no longer had much equity to tap. Banks also became more gun-shy, and borrowers may have been scarred by the experience of seeing so much of their wealth evaporate in a short period of time.
“I think there’s been a lot of fear around that product,” said Bill Handel, chief economist at Raddon, a financial research firm.
As home prices have recovered, the market has rebounded somewhat. Still, it often makes more sense for homeowners to refinance their entire mortgage than it does to take out a second loan.
While that calculus may start to change, assuming interest rates continue to rise, the new tax liability could be a disincentive for some borrowers to use home equity loans.