The Tax Loophole That Created the HELOC

The history of the home equity line of credit, or HELOC, is more recent than you’d think.

When Congress changed the tax code in 1986, they probably didn’t realize that they had opened a tax loophole, which would change home lending and consumer credit for decades.

The Tax Reform Act of 1986 eliminated tax deductions on many types of consumer interest, including credit cards and some loans, but it kept the mortgage interest deduction. Banks and lenders jumped on the carve-out and created new loans and products structured around this advantage.

The HELOC was born as a revolving line of credit backed by the wealth a homeowner built up in their home. Since then, it’s allowed homeowners to borrow with more flexible and favorable terms, including lower interest rates.

In this episode of “Footnotes of Finance,” Aven looks at how banks took advantage of a tax loophole in a 1986 law and changed home loans with the invention of the HELOC.

What is the history of the HELOC?

The home equity line of credit became popular after the Tax Reform Act of 1986 changed tax deductions for common types of consumer debt. The law kept mortgage interest deductions, and banks and other loan providers structured the HELOC around this tax advantage.

When was the HELOC invented?

HELOCs were created after 1986 changes to the tax code. Lenders created the HELOC to provide a loan product tied to mortgage interest deductibility.

How was the HELOC invented?

Banks and lenders invented the HELOC to align with new tax incentives after 1986, particularly the continued deductibility of mortgage interest, and provide credit for consumers.

How does a HELOC work?

A HELOC is a revolving line of credit secured by a borrower’s home. A lender extends credit based on home equity, or the value of the home minus any outstanding home-loan debt. A homeowner can then draw, repay and reuse funds from the HELOC, similar to a credit card.

Why is a HELOC tied to home equity?

A HELOC is secured by a borrower’s home. Mortgage-related debt, such as HELOCs, kept their favorable tax treatments with the Tax Reform Act of 1986, which made home equity helpful for lenders and borrowers as collateral.

Is the HELOC the same as a credit card?

No. A HELOC is secured debt backed by a home, while credit cards are a popular type of unsecured debt. Secured credit cards exist, but are less common.

A HELOC usually has longer repayment terms or structures and different credit requirements than credit cards. Notably, a lender can usually provide lower interest rates for a because a HELOC is less risky for them. HELOCs are backed by a borrower’s home and the home’s equity value.

Credit cards typically have higher interest rates than other loans or credit products, but can be easier to apply for and use.

What are common uses for a HELOC?

HELOCs can be used to pay for home improvements or repairs, debt consolidation, college tuition payments, medical bills and large purchases.

How did tax policy shape home lending?

The Tax Reform Act of 1986 helped make mortgages and other home loans, such as HELOCs, more attractive. Borrowers could deduct eligible home loan costs and interest, which helped make home lending more affordable than other types of credit. The law limited other consumer interest deductions, which encouraged home-secured borrowing.

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Watch the full video: The Tax Loophole That Created the HELOC

“Footnotes of Finance” explores the inner workings of the consumer finance industry. Every financial product has an origin story, and Aven breaks down the real story of how things work.

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Video transcript: The Tax Loophole That Created the HELOC

Did you know the HELOC as we know it today was actually born out of a tax loophole?

Before 1986, every credit card balance you carried came with the federal tax break. At the gas station, at the department store, consumer debt of any kind: all of it was a write-off.

But, of course, the federal government didn’t let that last any longer. With the Tax Reform Act of 1986, Congress killed it pretty much overnight.

But they did leave one deduction standing: mortgage interest.

And the banks saw this loophole before the ink was even dry.

So they built the bridge between unsecured consumer debt and home-secured debt.

They called it the home equity line of credit, or the HELOC, a product designed to patch a hole Congress didn’t even know it left open.

And for 40 years, it rewired how Americans thought about their homes, not just as a place to live, but as collateral.

But the traditional HELOC was always a clumsy product: weeks of paperwork, an appraiser at your door, a second closing. It’s a relic of 1986, frozen in 1986 mechanics.

But finally, the modern HELOC is here with Aven and the Home Equity credit card.