New Tax Law May Impact the Mortgage Market For Cash Out Refinances and Junior Liens Home Equity Loans

The new Tax Cuts and Jobs Act (“TCJA”) signed into law on December 22, 2017, may impact the mortgage market for cash out refinances and for junior mortgages taken in order to cash out home equity. Under the TCJA for the taxable years beginning January 1, 2018 through December 31, 2025, only interest on “acquisition indebtedness” of a principal residence and a second home is allowed to be deductible for taxpayers itemizing deductions. The TCJA does not allow deduction for interest on non-acquisition indebtedness, which the Internal Revenue Code (“IRC”) refers to as “home equity indebtedness”, regardless of when the home equity indebtedness was incurred or its lien position.

Under the IRC, the term “acquisition indebtedness” means any indebtedness that was incurred in acquiring, constructing, or substantially improving a principal residence and a second home and is secured by such residence. A mortgage loan remains an acquisition indebtedness even if it is later refinanced, but only to the extent that the amount of the new mortgage loan resulting from such refinancing does not exceed the amount of the mortgage loan refinanced.

Also, the TCJA reduced the aggregate dollar amount treated as acquisition indebtedness from $1,000,000 to $750,000 (or from $500,000 to $375,000 for married filing separately). However, this reduction only applies to loans taken on or after December 16, 2017. For loans taken on or before December 15, 2017, the $1,000,000 (or $500,000 for married filing separately) aggregate limit will continue to apply.

Takeaways

The TCJA may curb consumers’ appetite to take cash out refinance loans and cash out equity loans for non-deductible discretionary family and household purposes, such as buying a new car or paying for kids’ college. Therefore, the TCJA has the potential to reduce volumes of cash out refinances and equity loans.

On the other hand, cash out refinance and equity loans taken for substantial improvement of a principal residence or a second home will still be deductible under the TCJA up to the aggregate dollar limits and therefore the TCJA will likely not have an impact on such loans.

If you have any question regarding the TCJA impact on mortgages, please reach out to Solomon Maman.

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