How to deduct your home equity loan interest from your taxes

With 2023 over, millions of Americans turn with a hopeful eye toward 2024. While their finances may have been hurt by inflation and higher interest rates the year prior, there are some encouraging signs for a better calendar year. 

But first, they will need to complete their 2023 tax return. With taxes due on Monday, April 15, and with some Americans already starting to receive documentation from last year, now is an opportune time to get your tax situation in order.

This is particularly true for homeowners who tapped into their home equity last year. That's because these owners may be eligible to deduct the interest they paid on their loan from their soon-to-be-filed taxes. But how, exactly, do owners deduct their home equity loan interest from their taxes? That's what we'll break down below.

Learn how a home equity loan can qualify as a tax deduction here now.

How to deduct your home equity loan interest from your taxes

Only some borrowers will qualify for a home equity loan interest tax deduction. For example, if you used the proceeds from your loan to pay for a wedding or education expenses, you won't be able to deduct the interest you paid from your 2023 bill. Similarly, if you used the loan to buy a car or make a major purchase for yourself or a loved one, you won't qualify. 

However, according to the Internal Revenue Service (IRS), there are specific circumstances where you can deduct your home equity loan interest from your taxes. And if you've done work on your home in the same calendar year that you used the money, then you may qualify.

"Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan," the IRS notes online. "The loan must be secured by the taxpayer's main home or second home (qualified residence), and meet other requirements."

So how should homeowners deduct this interest if they're manually filing their own taxes? According to the IRS, there are some clear steps to take. 

"Generally, you can deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 8a," the agency says. "However, any interest showing in box 1 of Form 1098 from a home equity loan, or a line of credit or credit card loan secured by the property, is not deductible if the proceeds were not used to buy, build, or substantially improve a qualified home. If you paid more deductible interest to the financial institution than the amount shown on Form 1098, show the portion of the deductible interest that was omitted from Form 1098 on line 8b. Attach a statement to your paper return explaining the difference and print 'See attached' next to line 8b."

Start exploring your home equity loan options online now to learn more about this feature.

Why you should use a home equity loan

A home equity loan comes with multiple benefits, the interest tax deduction being just one of the major ones. Specifically, you should also consider using a home equity loan because of the following reasons:

• It comes with a locked interest rate: Unlike home equity lines of credit (HELOCs), home equity loans have a fixed interest rate, injecting some predictability into your budget.
• It has a lower interest rate than popular alternatives: Traditionally, because your home is being used as collateral in the process, home equity loans come with lower interest rates for qualified borrowers than popular alternatives like credit cards and personal loans.
• It offers access to a large amount of money: Some banks provide loans for up to 85% of the equity in your home. Considering that the average amount of home equity has increased in recent years, this means you could be sitting on a potentially large amount of money to use as you see fit. 

The bottom line

If you used a home equity loan in 2023, then you should pause before instinctively filing your tax return this year. You may be eligible to deduct the interest you paid on the loan from your taxes if used for eligible purposes like a home repair or qualifying renovation. As is the case with most personal financial decisions and tax preparations, however, be sure to consult your tax advisor or financial advisor before formally filing your return.