New tax law makes HELOCs less attractive for debt repayment
Sally Herigstad is a certified public accountant and the author of “Help! I Can't Pay My Bills: Surviving a Financial Crisis.” She writes “To Her Credit,” a weekly reader Q&A column about issues involving women and credit, for CreditCards.com. She also has written for MSN Money and Bankrate.com, and has guested on Martha Stewart Radio and other programs.
I wanted to take out a home equity line of credit to pay off $30,000 in card debt, but now that the interest is no longer deductible, what do I do?Most good financial decisions should be made by first considering the primary costs or benefits of the decision first, and then considering the tax implications. Saving on interest expenses is a huge benefit, even without the added bonus of being able to deduct the interest as you pay it off.
Dear To Her Credit,
I have $30,000 in credit card debt that I’m having trouble paying off. It seems like all my payments just go to interest.
I was planning to take out a home equity line of credit (HELOC) to pay off the debt. I can get a HELOC with a 5 percent interest rate vs. 18 percent on my credit cards.
I just heard that HELOC interest is no longer deductible under the new law. Now what do I do? Can I refinance my house with cash out, instead? – Sara
One of the big motivations in the past for taking out a HELOC to pay off credit card debt is that it’s one way to turn nondeductible, consumer debt interest into a deductible interest expense. Under the new tax law, that loophole is gone – effective immediately. Starting in 2018, interest on HELOCs is generally nondeductible, unless the money is spent to buy, build or substantially improve the home on which the loan is secured.
Advantages of a HELOC
Does that mean the HELOC is dead? I wouldn’t count on it. You’ve already mentioned the main appeal of a HELOC over carrying credit card debt or almost any other type of debt: lower interest rates. Exchanging an 18 percent credit card interest rate for a 5 percent rate on a loan, with or without a tax deduction for the interest, will save you a lot of interest expense. Now, when you make payments, a far greater portion of it should go to reducing your balance.
Another reason you might not want to worry too much about the “lost” deduction for HELOC interest is that you may not need to itemize deductions starting in 2018, anyway. The standard deduction has just about doubled for every tax filing status. Most people now will find they benefit more from the standard deduction than from itemizing deductions. (If your total itemized deductions, including the mortgage interest deduction, are greater than the new standard deduction, you can still itemize.)
Refinancing your home instead of getting a HELOC is always an option, but it won’t help you convert your credit card debt into tax-advantaged debt, however. Under the new tax law, if you refinance your home for more than your existing loan amount, and you don’t use the money to buy, build or significantly improve your home, you won’t be able to deduct mortgage interest on the portion of the loan that exceeds the one it replaced. So, you’re back to square one.
See related: HELOC vs. cash-our refinance for card debt repayment
Consider all the costs involved first
If you have to choose between getting a HELOC or refinancing your home to pay off credit card debt, instead of sticking to a strict repayment plan that you devise yourself, you should consider the interest rates and the cost of refinancing versus getting a HELOC. Be sure to ask your bank or mortgage broker about all your fees and costs for either type of loan, including appraisals and loan origination fees, before you decide. In my experience, the initial cost of the HELOC may be less because you are financing a smaller amount than with a complete refinancing.
Most good financial decisions should be made by first considering the primary costs or benefits of the decision first, and then considering the tax implications. Saving 13 percent per year in interest (18 percent minus 5 percent) expense on $30,000 is a huge benefit, even without the added bonus of being able to deduct the interest as you pay off your card debt. If the fact that you can’t deduct the interest motivates you to pay off the HELOC sooner, so much the better.
Disadvantages and alternatives to using a HELOC
The downside? The most attractive HELOC rates are variable, meaning they will rise over time if the Federal Reserve keeps on track with its plan to keep lifting its key lending rate. So that 5 percent rate isn’t guaranteed to stay the same for long. Plus, you’re trading unsecured debt for secured debt, so if you hit hard times and can’t pay the mortgage or HELOC, you risk losing your home.
Another alternative you may consider is applying for a couple of 0 percent cards, although you’d have to be incredibly disciplined in your repayment plan to get the balance down to zero before the promotional period ends. The U.S. Bank Visa Platinum card is currently offering a 20-month interest-free period with a 3 percent balance transfer fee and no annual fee.
You also could split up your existing credit card balance between a new 0 percent APR card and a HELOC or even just a personal loan. For example, let’s say you transfer $10,000 to the U.S. Bank Visa card and paid the remaining $20,000 with a HELOC. You could focus your initial repayment more heavily on the balance transfer card first by paying $515 a month for 20 months ($10,000 plus $300 for the balance transfer fee divided by 20 months). Then, once that is paid off, you could double-down on repaying the HELOC by applying that $515 toward the remaining debt.
Any way you choose, it’s going to take some time and commitment to whittle down that $30,000 in card debt.
As always, be careful when paying off debt by getting more debt. As part of a carefully executed strategy, paying off credit cards with a lower interest loan can make sense. If you might be tempted to run up your credit card balances again, however, watch out. It’s all too easy to spend the available credit again, and find yourself with twice as much debt as you had when you started.
Good luck as decide on the best strategy to get out of debt, and follow through on reaching your financial goals.
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