A home equity line of credit (HELOC) is, loosely speaking, like a credit card fo

Question

A home equity line of credit (HELOC) is, loosely speaking, like a credit card for your home. You can borrow money by drawing down on the line of credit. But, because the borrowed money is for the purpose of your home, the interest is tax-deductible meaning that you can deduct the interest paid on this money from your income to reduce your taxes. If the current annual interest rate on a HELOC is 3.85% and your tax rate is 32%, what is the after-tax interest rate you will pay on any borrowings under the HELOC? *Make sure to input all percentage answers as numeric values without symbols, and use four decimal places of precision. For example, if the answer is 6%, then enter 0.0600.

Explanation / Answer

As the interest is tax deductible, any deduction from the income on account of interest will result in tax benefits to the tune of the tax rate. So, (1-tax rate) is the actual interest paid by the borrower as the actual outflow on account of interest is post tax amount paid.

So, after tax interest rate = 3.85% x ( 1 - tax rate) = 3.85% x (1 - 0.32) = 2.618%.

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