Many people equate home improvement loans with home equity loans. And in fact, many financial professionals suggest that the best use for a home equity loan is for the purpose of home improvement. The reasoning behind this suggestion is that you are using your home equity to improve it and thus increase its value. It’s investing relatively low-cost money in your home, which will inevitably increase in value. You’re just helping it along with the addition of a pool, a garage or an irrigation system.
A home equity loan is secured by the equity you have gained in your property and probably offers the best interest rate available for a home improvement loan. Because this choice for a home improvement loan is in fact a second mortgage, the interest paid on the note is tax deductible. If you opt for a personal home improvement loan that does not involve using the house as collateral, interest on any portion of the loan that is actually used for home improvement is tax deductible.
There is a difference between home maintenance and home improvement in the eyes of the IRS. Interest on funds used for home improvement is deductible, while money used for maintenance is not. If you add a deck on the back of the house, that’s an improvement and qualifies for a tax deduction. Painting the kitchen is a maintenance cost and does not qualify for deduction.
If your home improvement loan is a second mortgage, generally you can also deduct the points paid for the loan in the year that you receive it. Home improvement loans can truly be a quality investment when they are loans taken as second mortgages. The interest rates will be for a secured loan – much lower than a personal loan for the same purpose – and the interest helps with tax reduction. There is a limit to the deductible interest for home improvement loans secured by home equity. The maximum loan for which deduction is allowable on the interest is $100,000.
If you choose the home equity route to fund your home improvements, be sure that the loan does not throw you into a situation that requires insurance on the principal mortgage. Most lenders will not allow the aggregate debt of the primary mortgage and the home improvement loan to extend beyond 80% of the home’s current appraised value – so personal mortgage insurance is not an issue. If your home improvement loan takes to the point where you have mortgages against 90% of 95% of the home’s value, you may be required to institute – or reinstitute – a mortgage insurance policy.
You should also make sure that your home improvement loan has no prepayment penalty. If you should decide to sell the home and move, it’s important that you be able to close out your mortgages with a minimum in additional costs.