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Which Interest Expense is Deductible?
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There are two types of interest for the income tax purposes, deductible and non-deductible. You can deduct the following types of interest:
- Home mortgage interest, including certain points, and
- Investment interest
- Interest you pay on a qualified student loan (you can deduct it even if you do not itemize. Certain income restrictions apply)
Personal interest is not deductible. Examples of personal interest include interest on a loan to purchase an automobile for personal use and credit card and installment interest incurred for personal expenses. Thus, the bad news is that not only interest rate this type of interest tend to be rather high, but you cannot use it to offset you tax burden.
But wait, if you own your home, things might be looking up for you. There's a way to convert your nondeductible interest payments into deductible expense. Specifically, you can take out a home equity loan (in the normal way, from your bank for example) and use the proceeds to pay off your nondeductible debts. You will probably be paying at a lower rate, since many lenders are charging near prime on these loans. And the interest payments will be deductible even though you don't use the loan for anything connected with the house.
Of course, before you borrow against the equity in your personal residence, you should be certain that you actually get the tax deduction benefit. As always, there are various technical restrictions and limits that may apply, depending on your particular tax facts and circumstances.
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