On my previous post “Why buying a home is better than renting,” I mentioned that one of the advantages of owning a home is that homes build equity. Equity is the difference between the current value of the house and the amount owed. Overtime, houses appreciate in values while your home mortgage decreases as you continue to make payments, thus, building a sizeable equity.

The tax advantage of owning a home is that homeowners can deduct the interest that they pay on their tax returns.  This applies to both the original (acquisition) mortgage and the home equity loans. As most of you know, the interest paid on car loans, credit cards, personal loans, and any other types of consumer loans (except for student loans) are not tax deductible. Moreover, the interest rates on most of these debts, especially credit cards, are at least 7%. By taking a home equity loan, you can pay out these high interest debts and replace them with a much lower interest rate loan. In essence, you are consolidating all your personal loans. In addition, the monthly payment on the home equity loan is much lower than the combined monthly payments of the other loans. Thus, freeing up more money that you can use for retirement or other investments.

However, there are limits on how much interest that you can deduct. Interest on up to $100,000 of home equity loans that are taken out for purposes other than to buy, build, or improve your home are deductible on your tax return throughout 2006. The limit is reduced to $50,000 if you are married and filing separately. Moreover, not all home equity loan interest is deductible for alternative minimum tax purposes. Lastly, keep in mind that if you fail to make payments on your equity loan, your house will be in serious trouble as banks can go after your property.

For more information on the interest expense deduction, please visit the Internal Revenue Website or consult a tax practitioner for your specific case.