How Will Recent 2018 Tax Changes Impact Home Equity Products?
Recent changes to the US tax code will affect homeowners with mortgage and home equity products in a number of ways. In this Raddon Report, we look at what has changed, who will be affected, the impact of the change on homeowners, and what institutions can do to market their mortgage and equity products in this new environment.
What Has Changed?
There are two major changes that will potentially affect homeowners. First, mortgage interest deductibility will be limited to primary residences and on loans only up to $750,000 (versus $1,000,000 under the prior law). Note that existing mortgages will be grandfathered. Second, the new law eliminates the tax deductibility for interest paid on home equity loans and home equity lines of credit (HELOCs). Previously, interest paid on home equity products was deductible up to $100,000 and consumers regularly used home equity products to gain a tax advantage when purchasing boats, recreational vehicles, autos, tuition and other needs. There will be no grandfathering for existing home equity holders.
However, the impact of these changes will be offset for some consumers as the standard deduction will be nearly doubled to $24,000 for married couples filing jointly (versus $12,700 under the prior law).
Who Will be Affected?
The new law will affect consumers who continue to itemize deductions in 2018 and beyond. For the 2016 tax year, only 30% of households itemized tax deductions and of those, approximately three quarters included mortgage interest or interest from home equity products. With the large increase in the standard deduction, the percentage of those itemizing is expected to decline significantly. This reduction in the number of taxpayers itemizing will also be driven by the new $10,000 cap on property, state and local taxes.
What Will be the Impact on Consumers?
As examples of the potential impact of the loss of deductibility of interest on home equity products, we looked at the key Raddon Consumer Segments who most use home equity products. These are the Upscale, Middle Income Depositors, and Middle Market segments. The average household income for the Upscale group is $173,000, for Middle Income Depositors, $80,000, and for Middle Market, $81,000.
The revised tax brackets will place most Upscale households in the 22% bracket and Middle Income Depositors and Middle Market households in the 12% bracket (after taking the standard deduction).
Based on Raddon’s Performance Analytics, September 2017 data, for newly opened home equity products, the average size of a new HELOC was $31,730 and the average home equity loan was $49,141. The following table shows the impact of the lost tax deductibility for a typical upscale household with an average sized loan, assuming a 22% marginal tax rate.
While the $300 - $500 impact of the lost tax deduction for the average borrower is significant, many consumers will continue to find HELOCs and Home Equity loans to be attractive compared to unsecured consumer loans that currently carry interest rates around 8 percent. The upshot is that home equity lending is not dead, but it has changed, and financial institutions should recognize and adapt to these changes.
Next Steps for Financial Institutions
The net result is that the overall impact of the tax law changes should not have a big effect on the marketability of home equity products. While the small proportion of homeowners who continue to itemize deductions after the tax law change will pay additional taxes, home equity products will still offer significantly lower rates, even without the former tax benefits.
The changes are likely to result in some confusion among consumers and our institutions will need to address the changes both in how they market their products and in the training of their staff. Here are a number of things to consider immediately.
- Institutions need to provide on-going consumer education to reinforce the value of home equity products even without the interest rate deductibility benefit. Home equity products will continue to offer lower interest rates due to the secured nature of the loans along with flexible terms ranging from interest only to 10 – 15 year fixed loans.
- Institutions should immediately modify marketing materials and websites to remove reference to the tax benefits of the home equity products while stressing the ongoing advantages of the products.
- Institutions should monitor annual growth goals that were set for home equity products for 2018. Will these need to be readdressed? Will existing balances pay off at a quicker rate? We expect the impact of the changes to be minimal but the impact of the changes still warrant careful monitoring.
- The tax law changes create an opportunity for institutions to promote “cash out” mortgage refinance as an alternative to home equity products. These products allow the consumer to refinance an existing mortgage loan for a new larger amount with the borrower getting the difference in the loan amount in cash. This allows consumers to extract equity from their homes while preserving the tax deductibility of interest. A typical loan to value is 80- 85%. The interest rate is often lower than a home equity but closing costs are typically involved.
- The new environment may also provide an opportunity to promote “unsecured” home improvement loans. These types of loans are often marketed as homeowner express loans. Interest rates are more competitive than the standard unsecured personal loan. They are available to homeowners but no home equity is required and no lien is place on the property. There are no closing costs or appraisals. Access to funds can be as quick as same day. Typical loan amounts range from $5,000 up to $100,000 and fixed terms are available up to 10 years. Home improvements and financing of a major expense are the main uses.
The bottom line is that there will be a lot of confusion among consumers – especially users of home equity products – and your opportunity will be to provide them with the tools that allow them to make the decisions that are right for them. Do not consider home equity as a defunct product but focus on the new opportunities with this product.