Tapping Your Home Equity

Your home equity is the difference between what the place is worth and what you owe on loans secured by the property. If you could sell for $100,000 and the balance on your mortgage is $60,000, for example, your equity is $40,000.

Your equity should increase each year as your home appreciates and monthly payments reduce what's owed on the mortgage. Home equity could be the major building block of your net worth.

More and more homeowners have been dipping into that equity by borrowing against it. The appeal of this kind of debt is that interest paid on the loan is generally fully deductible on your tax return, while interest paid on other consumer loans is not. (But be cautious: Casual use will drain your home equity; worse, it could cause you to lose your home.) If the money will be used to improve your home, the sky's the limit. You can deduct up to $1 million of mortgage debt used to buy a home or make major improvements. For other home-equity debt, the cap is $100,000 (beyond the loan you took to buy the house). It's deductible for any use except buying tax-exempt bonds or single-premium life insurance.

In other words, the government subsidizes the cost of borrowing if the loan is secured by your home. Consider what that means on a $10,000, ten-year loan at 8.5%. In the first 12 monthly payments, interest totals $825. If the loan is secured by your home and the $825 is deducted in the 27% bracket, the federal government effectively pays $223 of the interest. (Your state government might help, too, assuming you also get the benefit of the deduction on your state return.)

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