HELOC on a rental. Is the interest tax deductible against the rental income?

[clarkfan1979]

I'm considering doing a re-fi or a HELOC on an investment property. I'm currently at 4.5% and I'm 2 years into my loan. The house is worth 800K and I owe 464K.

A straight re-fi is 3.375% and a cash-out is 3.625%. However, they both require 1.825% points, which is $10,950 on a 600K loan. It would be another $7,000-$9,000 for the other closing costs, so total closing costs would be $18,000-$20,000. Ouch.

Bank of Hawaii is offering 3.54% fixed HELOC for investment property. They do 80% LTV on first position and 70% LTV on second position. It's about $2500-$3000 in total closing costs.

If I did a first position, my payment for PITI would immediately drop from 2,444/month to 2,094/month, a difference of $350/month. However, I am not sure if the interest on the HELOC is tax deductible against the rental income.

 

[SndcxxJ]

I am not an accountant, but I believe the answer is maybe.
It will depend on what you use the cash for, if you use the cash from the cash out refinance to go on vacation, the interest is NOT deductible.  If you use the cash to build an ADU that you rent out for profit, or improve the rental property you have borrowed against, it WOULD be deductible.  I believe it is called interest tracing by the IRS and I don't think it is limited to HELOCs.  I believe even if you do a traditional conforming cash out refi the interest tracing rules apply.  As long as the cash is used for an investment purpose (as compared to a personal purpose) the interest is deductible. 

[uniwelder]

My understanding is the same as SndcxxJ.  PenFed will also do HELOC's on investment properties, as long as you own no more than 4 I believe.  I took one out a couple of years ago with no fees, but I think the interest rate would probably be higher than 3.5%.  What's your plan on repaying the loan?  I took out 80k for a downpayment on another house, and am just paying the interest for now.  Its taken a huge hit to my credit rate, dropping about 50 points because a heloc doesn't count the same as a mortgage for credit score calculations--- its like a credit card, so your credit utilization % will skyrocket.  Before we apply for another mortgage, I'm going to convert the heloc for repayment, which should fix the credit score issue, making it count as a bank loan.

[uniwelder]

I just looked up at PenFed's site--- heloc rates are 4.75% with max 400k credit, so scratch that.

Something I didn't understand in the original post is the monthly payment.  I'm generally familiar with helocs with a 10-15 year repayment period, so your monthly payment would be at least $3,300/month in that case.  What are the terms of the heloc you're looking into and the repayment plan?

[srad]

A straight re-fi is 3.375% and a cash-out is 3.625%. However, they both require 1.825% points, which is $10,950 on a 600K loan. It would be another $7,000-$9,000 for the other closing costs, so total closing costs would be $18,000-$20,000. Ouch.

Those fee's add up, if i'm not mistaken the new freddie/fannie .05% mortgage fee just went into effect, which for you will be around 3k, yeah, ouch. 

As for heloc, I'm with the others, if you buy a property you are good.  Also in the past I never considered a heloc, if i needed money I just cashout refi, its hard to beat a fixed 30 year rate.  However, up until recently closing costs were tolerable.

[Dicey]

A straight re-fi is 3.375% and a cash-out is 3.625%. However, they both require 1.825% points, which is $10,950 on a 600K loan. It would be another $7,000-$9,000 for the other closing costs, so total closing costs would be $18,000-$20,000. Ouch.

Those fee's add up, if i'm not mistaken the new freddie/fannie .05% mortgage fee just went into effect, which for you will be around 3k, yeah, ouch. 

As for heloc, I'm with the others, if you buy a property you are good.  Also in the past I never considered a heloc, if i needed money I just cashout refi, its hard to beat a fixed 30 year rate.  However, up until recently closing costs were tolerable.

I thought those fees got postponed. Sorry, OP, I can't answer the question.

[srad]

Just checked, fee is postponed to Dec 1st.  So if you are to refi, better get on it, 

[SeaWA]

Whatever you choose, encourage you to shop around for a refi.

I closed a refi last week (though not with cash out). During my due diligence phase I got estimates from 4 lenders. The top rate was 3.25% and the bottom rate was 2.875% (with nearly identical closing costs, and buying zero points).

Over the years that 0.375% difference is going to create a lot more green worker bees in my index funds.

[uniwelder]

SeaWA, was this on an investment property? That’s a very low rate if so.

Investment properties will generally have rates .5-.75% higher than a primary home.  I've understood a lot of lenders weren't even doing refinances on investment properties due to concerns of vacancy/unemployment of tenants.  As far as HELOC's go, I think there are only a few lenders that will allow it for investment properties.

[SeaWA]

SeaWA, was this on an investment property? That’s a very low rate if so.

Investment properties will generally have rates .5-.75% higher than a primary home.  I've understood a lot of lenders weren't even doing refinances on investment properties due to concerns of vacancy/unemployment of tenants.  As far as HELOC's go, I think there are only a few lenders that will allow it for investment properties.

This was a former investment property that I owner occupied and refinanced. Your point is well taken. I should have mentioned that, to not give a false sense of the interest rate OP could get.Yes, refi for investment properties is higher.

I was trying to contribute by recommending that the OP ensure they get multiple quotes, because there is so much variance between lenders.

[clarkfan1979]

I am not an accountant, but I believe the answer is maybe.
It will depend on what you use the cash for, if you use the cash from the cash out refinance to go on vacation, the interest is NOT deductible.  If you use the cash to build an ADU that you rent out for profit, or improve the rental property you have borrowed against, it WOULD be deductible.  I believe it is called interest tracing by the IRS and I don't think it is limited to HELOCs.  I believe even if you do a traditional conforming cash out refi the interest tracing rules apply.  As long as the cash is used for an investment purpose (as compared to a personal purpose) the interest is deductible.

I'm not taking any cash out with the HELOC. As far as I understand the first position HELOC is simply replacing my mortgage. We are in a weird situation right now where a HELOC is cheaper than a mortgage and lower closing costs. The Bank of Hawaii HELOC is now 3.45% and it is a fixed rate. If I was to re-fi, it's 3.625%.

I have received multiple quotes from mortgage brokers and they all pretty say the same thing for points, rates and 50-60 days to close. If a lender is scheduled to close Nov 15-30, they add in the 0.5% points. As a result, I'm already going to pay for the fee.

[uniwelder]

Clarkfan, What are the details for the heloc? Do you have to keep it open for a certain amount of time before converting it to repayment? How long is the repayment period?

[clarkfan1979]

All of the info is on the Bank of Hawaii website. I'm talking to a loan officer from Bank of Hawaii on Friday regarding more specifics.

[uniwelder]

I'm curious for an update after you discuss Friday.  I saw a 30 year fixed loan at 3.45%, but no mention of investment properties.  Sounds too good to be true, but hopefully it'll work out for you.

[bacchi]

I'm not taking any cash out with the HELOC. As far as I understand the first position HELOC is simply replacing my mortgage. We are in a weird situation right now where a HELOC is cheaper than a mortgage and lower closing costs. The Bank of Hawaii HELOC is now 3.45% and it is a fixed rate. If I was to re-fi, it's 3.625%.

Why wouldn't it be tax deductible? If you were getting a business loan from an investment club or your parents or a loan shark, that would also be tax deductible.

[clarkfan1979]

It turns out that I do not qualify for a first position HELOC because of my debt to income. This is confusing because my monthly payment would go down from $2,444 (PI) to 2,071 (PI)

The underwriters at the Bank of Hawaii use 1% of the total loan as the estimated monthly debt payment (not the actual payment). If I am borrowing $464,000 on the HELOC, the underwriters use $4640 as the monthly debt payment within the debt to income formula (not the actual payment of 2,071). If the payment on the rental is now estimated to be $4640/month (for underwriting purposes), I do not have enough income to get under 45% (debt to income).

I have never done a HELOC before. Is it normal to use 1% of the loan balance as the estimated monthly debt payment? Is Bank of Hawaii able to offer the low rate HELOC's because their underwriting is super conservative?

Something similar is happening to my student loans. My student loan balance of $24,400 is on a 25-year graduated plan and my payment is $156/month. Because all loans are in forbearance right now, no payments are actually due. Underwriters are using 1% of the total balance as the estimated monthly payment. To an underwriter, my student loan payment monthly debt is now $244/month instead of $156/month. 

[uniwelder]

Sorry it didn't work out, and for reasons that don't seem logical.  Sounds like something for the thread on underwriter frustrations.

[fishnfool]

Try Aimloan. I have used them for my HI property when its was an investment loan. Now doing a refi as owner occupied 2 unit property. Locked in at 2.875%. I know a HELOC is a higher rate, but they have very competitive rates and you can get a online quote off their website without any info exchanged to compare rates. closing costs etc.