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If you own a home, you may be interested in tapping into your available home equity. One popular way to do that is with a home equity line of credit. This is different from a home equity loan, and can help you finance a major renovation or many other expenses.

Homeowners sitting on at least 20% equity — the home’s market value minus what is owed — may be able to secure a HELOC.

Here, you’ll take a closer look at this loan product, including:

•   What is a HELOC loan?

•   How does a HELOC loan work?

•   What are the pros and cons of a HELOC?

•   What are alternatives to a HELOC?

How Does a HELOC Work?

The purpose of a HELOC is to tap your home equity to get some cash to use on a variety of expenses. Home equity lines of credit offer what’s known as a revolving line of credit, similar to a credit card, and usually have low or no closing costs. The interest rate is likely to be variable (more on that in a minute), and the amount available is typically 75% to 85% of your home’s value.

Once you secure a HELOC with a lender, you can draw against your approved credit line as needed until your draw period ends, which is usually 10 years. You then repay the balance, typically over 20 years, or refinance to a new loan. Worth noting: Payments may be low during the draw period; you might be paying interest only, and then face steeper monthly payments during the repayment phase. Carefully review the details when applying for a HELOC to understand what kind of debt you will be taking on.

Here’s a look at possible HELOC uses:

•   HELOCs can be used for anything but are commonly used to cover big home expenses, like a home remodeling costs or building an addition. These expenditures have been rising steeply: The number of home-improvement projects grew 17% to almost 135 million and spending ticked up 20% to $624 billion, according to recent American Housing Survey data.

•   Personal spending: If, for example, you are laid off, you could tap your HELOC for cash to pay bills. Or you might dip into the line of credit to pay for a wedding (you only pay interest on the funds you are using, not the approved limit).

•   A HELOC can also be used to consolidate high-interest debt. Whatever homeowners use a home equity line or loan for — investing in a new business, taking a dream vacation, funding a college education — they need to remember that they are using their home as collateral. That means if they can’t keep up with payments, the lender may force the sale of the home to satisfy the debt.

HELOC Options

Most HELOCs offer a variable interest rate, but you may have a choice. Here are the two main options:

•   Fixed Rate With fixed-rate home equity lines of credit, the interest rate is set and does not change. That means your monthly payments won’t vary either.

•   Variable Rate Most HELOCs have a variable rate, which is frequently tied to the prime rate, a benchmark index that closely follows the economy. Even if your rate starts out low, it could go up. Or, in these inflationary times, it might go down in the future. A margin is added to the index to determine the interest you are charged. In some cases, you may be able to lock a variable-rate HELOC into a fixed rate.

•   Hybrid fixed-rate HELOCs are not the norm but have gained attention. They allow a borrower to withdraw money from the credit line and convert it to a fixed rate.

HELOC Requirements

Now that you know what a HELOC is, think about what is involved in getting one. If you do decide to apply for a home equity line of credit, you will likely be evaluated on the basis of these criteria:

•   Home equity percentage: Lenders typically look for at least 15% or more commonly 20%.

•   A good credit score: Usually, a score of 680 will help you qualify, though many lenders prefer 700+. If you have a credit score between 621 and 679, you may be approved by some lenders.

•   Low debt-to-income (DTI) ratio: Here, a lender will see how your total housing costs and other debt (say, student loans) compare to your income. The lower your DTI percentage, the better you look to a lender. Your DTI will be calculated by your total debt divided by your monthly gross income. A lender might look for a figure in which debt accounts for anywhere between 36% to 50% of your total monthly income.

Other angles that lenders may look for is a specific income level that makes them feel comfortable that you can repay the debt, as well as a solid, dependable payment history. These are aspects of the factors mentioned above, but some lenders look more closely at these as independent factors.

Example of a HELOC

Here’s an example of how a HELOC might work. Let’s say your home is worth $300,000 and you currently have a mortgage of $200,000. If you seek a HELOC, the lender might allow you allows you to borrow up to 80% of your home’s value:

   $300,000 x 0.8 = $240,000

Next, you would subtract the amount you owe on your mortgage ($200,000) from the qualifying amount noted above ($240,000) to find how big a HELOC you qualify for:

   $240,000 – $200,000 = $40,000.

One other aspect to note is a HELOC will be repaid in two distinct phases:

•   The first part is the draw period, which typically lasts 10 years. At this time, you can borrow money from your line of credit. Your minimum payment may be interest-only, though you can pay down the principal as well, if you like.

•   The next part of the HELOC is known as the repayment period, which is often also 10 years, but may vary. At this point, you will no longer be able to draw funds from the line of credit, and you will likely have monthly payments due that include both principal and interest. For this reason, the amount you pay is likely to rise considerably.

Difference Between a HELOC and a Home Equity Loan

Here’s a comparison of a home equity line of credit and a home equity loan.

•   A HELOC is a revolving line of credit that lets you borrow money as needed, up to your approved credit limit, pay back all or part of the balance, and then borrow up to the limit again through your draw period, typically 10 years.

   The interest rate is usually variable. You pay interest only on the amount of credit you actually use. It can be good for people who want flexibility in terms of how much they borrow and how they use it.

•   A home equity loan is a lump sum with a fixed rate on the loan. This can be a good option when you have a clear use for the funds in mind and you want to lock into a fixed rate that won’t vary.

Borrowing limits and repayment terms may also differ, but both use your home as collateral. That means if you were unable to make payments, you could lose your home.

Recommended: What are the Different Types of Home Equity Loans?

What Is the Process of Applying for a HELOC?

If you’re ready to apply for a home equity line of credit, follow these steps:

•   First, it’s wise to shop around with different lenders to reveal minimum credit score ranges required for HELOC approval. You can also check and compare terms, such as periodic and lifetime rate caps. You might also look into which index is used to determine rates and how much and how often it can change.

•   Then, you can get specific offers from a few lenders to see the best option for you. Banks (online and traditional) as well as credit unions often offer HELOCs.

•   When you’ve selected the offer you want to go with, you can submit your application. This usually is similar to a mortgage application. It will involve gathering documentation that reflects your home’s value, your income, your assets, and your credit score. You may or may not need a home appraisal.

•   Lastly, you’ll hopefully hear that you are approved from your lender. After that, it can take approximately 30 to 60 days for the funds to become available. Usually, the money will be accessible via a credit card or a checkbook.

How Much Can You Borrow With a HELOC?

Depending on your creditworthiness and debt-to-income ratio, you may be able to borrow up to 85% of the value of your home (or, in some cases, even more), less the amount owed on your first mortgage.

Thought of another way, most lenders require your combined loan-to-value ratio (CLTV) to be 85% or less for a home equity line of credit.

Here’s an example. Say your home is worth $500,000, you owe $300,000 on your mortgage, and you hope to tap $120,000 of home equity.

Combined loan balance (mortgage plus HELOC, $420,000) ÷ current appraised value (500,000) = CLTV (0.84)

Convert this to a percentage, and you arrive at 84%, just under many lenders’ CLTV threshold for approval.

In this example, the liens on your home would be a first mortgage with its existing terms at $300,000 and a second mortgage (the HELOC) with its own terms at $120,000.

How Do Payments On a HELOC Work?

During the first stage of your HELOC loan (what is called the draw period), you may be required to make minimum payments toward your HELOC. These are often interest-only payments.

Once the draw period ends, your regular HELOC repayment period begins, when payments must be made toward both the interest and the principal.

Remember that if you have a variable-rate HELOC, your monthly payment could fluctuate over time. And it’s important to check the terms so you know whether you’ll be expected to make one final balloon payment at the end of the repayment period.

Pros of Taking Out a HELOC

Here are some of the benefits of a HELOC:

Initial Interest Rate and Acquisition Cost

A HELOC, secured by your home, may have a lower interest rate than unsecured loans and lines of credit. What is the interest rate on a HELOC? The average HELOC loan rate as of December 15, 2022, was 7.31%.

Lenders often offer a low introductory rate, or teaser rate. After that period ends, your rate (and payments) increase to the true market level (the index plus the margin). Lenders normally place periodic and lifetime rate caps on HELOCs.

The closing costs may be lower than those of a home equity loan. Some lenders waive HELOC closing costs entirely if you meet a minimum credit line and keep the line open for a few years.

Taking Out Money as You Need It

Instead of receiving a lump-sum loan, a HELOC gives you the option to draw on the money over time as needed. That way, you don’t borrow more than you actually use, and you don’t have to go back to the lender to apply for more loans if you end up requiring additional money.

Only Paying Interest on the Amount You’ve Withdrawn

Paying interest only on the amount plucked from the credit line is beneficial when you are not sure how much will be needed for a project or if you need to pay in intervals.

Also, you can pay the line off and let it sit open at a zero balance during the draw period in case you need to pull from it again later.

Cons of Taking Out a HELOC

Now, here are some downsides of HELOCs to consider:

Variable Interest Rate

Even though your initial interest rate may be low, if it’s variable and tied to the prime rate, it will likely go up and down with the federal funds rate. This means that over time, your monthly payment may fluctuate and become less (or more!) affordable.

Variable-rate HELOCs come with annual and lifetime rate caps, so check the details to know just how high your interest rate might go.

Potential Cost

Taking out a HELOC is placing a second mortgage lien on your home. You may have to deal with closing costs on the loan amount, though some HELOCs come with low or zero fees. Sometimes loans with no or low fees have an early closure fee.

Your Home Is on the Line

If you aren’t able to make payments and go into loan default, the lender could foreclose on your home. And if the HELOC is in second lien position, the lender could work with the first lienholder on your property to recover the borrowed money.

Adjustable-rate loans like HELOCs can be riskier than others because fluctuating rates can change your expected repayment amount.

It Could Affect Your Ability to Take On Other Debt

Just like other liabilities, adding on to your debt with a HELOC could affect your ability to take out other loans in the future. That’s because lenders consider your existing debt load before agreeing to offer you more.

Lenders will qualify borrowers based on the full line of credit draw even if the line has a zero balance. This may be something to consider if you expect to take on another home mortgage loan, a car loan, or other debts in the near future.

What Are Some Alternatives to HELOCs

If you’re looking to access cash, here are HELOC options.

Cash-Out Refi

With a cash-out refinance, you replace your existing mortgage with a new mortgage given your home’s current value, with a goal of a lower interest rate, and cash out some of the equity that you have in the home. So if your current mortgage is $150,000 on a $250,000 value home, you might aim for a cash-out refinance that is $175,000 and use the $25,000 additional funds as needed.

Lenders typically require you to maintain at least 20% equity in your home (although there are exceptions). Be prepared to pay closing costs.

Generally, cash-out refinance guidelines may require more equity in the home vs. a HELOC.

Recommended: Cash Out Refi vs. Home Equity Line of Credit: Key Differences to Know

Home Equity Loan

What is a home equity loan again? It’s a lump-sum loan secured by your home. These loans almost always come with a fixed interest rate, which allows for consistent monthly payments.

Some lenders will reduce or waive the closing costs if you don’t pay off the loan within a particular period.

Personal Loan

If you’re looking to finance a big-but-not-that-big project for personal reasons and you have a good estimate of how much money you’ll need, a low-rate personal loan that is not secured by your home could be a better fit.

With possibly few to zero upfront costs and minimal paperwork, a fixed-rate personal loan could be a quick way to access the money you need. Just know that an unsecured loan usually has a higher interest rate than a secured loan.

A personal loan might also be a better alternative to a HELOC if you bought your home recently and don’t have much equity built up yet.

The Takeaway

If you are looking to tap the equity of your home, a HELOC can give you money as needed, up to their approved limit, during a typical 10-year draw period. The rate is usually variable. Sometimes closing costs are waived. It can be an affordable way to get cash to use on anything from a home renovation to college costs.

If a home equity line of credit sounds right for you, see what SoFi offers. We have HELOC options that allow you to access up to 95% or $500,000 of your home’s value at competitively low rates. Plus, the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit brokered by SoFi.

FAQ

What can you use a HELOC for?

It’s up to you what you want to use the cash from a HELOC for. You could use it for a home renovation or addition, or for other expenses, such as college costs or a wedding.

How can you find out how much you can borrow?

Lenders typically require 20% equity in your home and then offer up to 85% or even more of your home’s value, minus the amount owed on your mortgage. There are online tools you can use to determine the exact amount, or contact your bank or credit union.

How long do you have to pay back a HELOC?

Typically, home equity lines of credit have 20-year terms. The first 10 years are considered the draw period and the second 10 years are the repayment phase.

How much does a HELOC cost?

When evaluating HELOC offers, check interest rates, the interest-rate cap, closing costs (which may or may not be billed), and other fees to see just how much you would be paying.

Can you sell your house if you have a HELOC?

Yes, you can sell a house if you have a HELOC. The home equity line of credit balance will typically be repaid from the proceeds of the sales when you close, along with your mortgage.

Does a HELOC hurt your credit?

A HELOC can hurt your credit for a short period of time. Applying for a home equity line can temporarily lower your credit score because a hard credit pull is part of the process when you seek funding. This typically takes your score down a bit.

How do you apply for a HELOC?

First, you’ll shop around and collect a few offers. Once you select the one that suits you best, applying for a HELOC involves sharing much of the same information as you did when you applied for a mortgage. You need to pull together information on your income and assets. You will also need documentation of your home’s value and possibly an appraisal.

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SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Home equity loans, home equity lines of credit (HELOCs), and cash-out refinances are all borrowing options that allow homeowners to access the equity they’ve built in their home. By tapping into home equity — the difference between a home’s current value and the amount still owed on the mortgage — homeowners can secure funds to meet other financial goals, such as making home improvements.

While these three types of loans do have similarities, there also are key differences in how each one works. Understanding the differences in a home equity loan vs. HELOC vs. cash-out refi can help you better determine which option is right for you.

Defining Home Equity Loans, HELOCs, and Cash-Out Refi

To start, it’s important to know the basic definitions of home equity loans, HELOCs, and cash-out refinances.

Home Equity Loan

A home equity loan allows a homeowner to borrow a lump sum that they’ll then repay over a set period of time in regular installments at a fixed interest rate. Generally, lenders will allow homeowners to borrow up to 75% to 85% of their home’s equity.

This loan is in addition to the existing mortgage, making it a second mortgage. As such, a borrower usually will make payments on this loan in addition to their monthly mortgage payments.

HELOC

A HELOC is a line of credit secured by the borrower’s home that they can access on an as-needed basis, up to the borrowing limit. The amount of the line of credit is determined by the mortgage lender and based on the amount of equity a homeowner has built, though it’s usually around 80% to 90% of the equity amount. Like a home equity loan, this is a second mortgage that a borrower assumes alongside their existing home loan.

How HELOCs work is somewhat like a credit card, in that it’s a revolving loan. For example, if a borrower is approved for a $30,000 home equity line of credit, they can access it when they want, for the amount they choose (though there may be a minimum draw requirement). The borrower is only charged interest on and responsible for repaying the amount they borrowed.

Another point that borrowers should keep in mind is that there is a draw period of 5 to 10 years, during which a borrower can access funds, and a repayment period of 10 to 20 years. During the draw period, the monthly payments can be relatively low because the borrower pays interest only. During the repayment period, on the other hand, the payments can increase significantly because both principal and interest have to be paid.

Cash-Out Refinance

A cash-out refinance is a form of mortgage refinancing that allows a borrower to refinance their current mortgage for more than what they currently owe in order to receive extra funds. With a cash-out refinance, the borrower’s current mortgage is replaced by an entirely new loan.

As an example, let’s say a borrower owns a home worth $200,000 and owes $100,000 on their mortgage at a high interest rate. They could refinance at a lower interest rate, while at the same time taking out a larger mortgage. For instance, they could refinance the mortgage at $130,000. In this case, $100,000 would replace the old mortgage, and the borrower would receive the remaining amount of $30,000 in cash.

Recommended: Home Buyer’s Guide

Home Equity Loans and HELOCs vs Cash-Out Refi

Here’s a look at how a home equity loan vs. HELOC vs. cash-out refinance stack up when it comes to everything from borrowing limit to interest rate to fees:

	Home Equity Loan	HELOC	Cash-Out Refinance
Borrowing Limit	75% to 85% of borrower’s equity	Up to 85% of borrower’s equity	80% of borrower’s equity
Interest Rate	Fixed rate	Generally variable	May be fixed or variable
Type of Credit	Installment loan: Borrowers get a specific amount of money all at once that they then repay in regular installments throughout the loan’s term (generally 5 to 30 years).	Revolving credit: Borrowers receive a line of credit for a specified amount and have a draw period (5 to 10 years), followed by a repayment period (10 to 20 years).	Installment loan: Borrowers receive a lump sum payment from the excess funds of their new mortgage, which has a new rate and repayment terms (generally 15 to 30 years).
Fees	Closing costs (typically 2% to 5% of the loan amount)	Closing costs (typically 2% to 5% of the loan amount), as well as other possible costs, depending on the lender (annual fees, transaction fees, inactivity fees, early termination fees)	Closing costs (typically 3% to 5% of the loan amount)
When It Might Make Sense to Borrow	Home equity loans can make sense for borrowers who want predictable monthly payments, or who want to consolidate higher interest debt.	HELOCs can be useful for shorter-term needs or situations where a borrower may want to access funds over a specified period of time.	Cash-out refinances may be useful if borrowers need a large sum of money, often used to improve their overall financial situation (for example, to pay off debt or finance a large home improvement project).

Borrowing Limit

With a home equity loan, lenders generally allow you to borrow up to 75% to 85% of a home’s equity. HELOCs allow borrowers to tap a similar amount, generally up to 85%. Cash-out refinances, on the other hand, have slightly lower borrowing limits, at up to 80% of a borrower’s equity.

Interest Rate

With a home equity line of credit, the interest rate is usually adjustable. This means the interest rate can rise, and if it does, the monthly payment can increase. Home equity loans, meanwhile, generally have a fixed interest rate, meaning the interest rate remains unchanged for the life of the loan. This allows for more predictable monthly payment amounts.

A cash-out refinance can have either a fixed rate or an adjustable rate. Homeowners who opt for an adjustable rate may be able to access more equity overall.

Type of Credit

Both home equity loans and cash-out refinances are installment loans, where you receive a lump sum that you’ll then pay back in regular installments. A HELOC, on the other hand, is a revolving line of credit. This allows borrowers to take out and pay back as much as they need at any given time during the draw period.

Fees

With a home equity loan, HELOC, or cash-out refinance, borrowers may pay closing costs. HELOC closing costs may be lower compared to a home equity loan, though borrowers may incur other costs periodically as well, such as annual fees, charges for inactivity, and early termination fees. Cash-out refinances may also have higher closing costs because the loan amount taken out is higher.

When It Might Make Sense to Borrow

A home equity loan vs. HELOC vs. cash-out refi have varying use cases. With a fixed interest rate, home equity loans can allow for predictable payments. Their lower interest rates can make them an option for borrowers who want to consolidate higher interest debt, such as credit card debt.

HELOCs, meanwhile, provide more flexibility as borrowers can take out only as much as they need, allowing borrowers to continually access funds over a period of time. A cash-out refinance can be a good option for a borrower who wants to receive a large lump sum of money, such as to pay off debt or finance a large home improvement project.

Which Option Is Better?

Like most things in the world of finance, the answer to whether a cash-out refinance vs. HELOC vs. home equity loan is better will depend on a borrower’s financial circumstances and unique needs.

In all cases, borrowers are borrowing against the equity they’ve built in their home, which comes with risks. If a borrower is unable to make payments on their HELOC or cash-out refinance or home equity loan, the consequence could be selling the home or even losing the home to foreclosure.

Scenarios Where Home Equity Loans Are Better

A home equity loan can be the right option in certain scenarios, including when:

•   You want fixed, regular second mortgage payments: A home equity loan generally will have a fixed interest rate, which can be helpful for budgeting as monthly payments will be more predictable. Some may appreciate this regularity for their second monthly mortgage payment.

•   You want to get a lump sum while keeping your existing mortgage intact: Unlike a HELOC, where you draw just as much as you need at any given time, a home equity loan gives you a lump sum all at once. Plus, unlike a cash-out refinance, you aren’t replacing your existing mortgage. That way, if the terms of your current mortgage are favorable, those can remain as is.

Recommended: The Different Types Of Home Equity Loans

Scenarios Where HELOCs Are Better

In the following situations, a HELOC may make sense:

•   You have shorter-term or specific needs: Because HELOCs generally have a variable interest rate, they can be useful for shorter-term needs or for situations where a borrower may want access to funds over a certain period of time, such as when completing a home renovation.

•   You want the option of interest-only payments: During the draw period, HELOC lenders often offer interest-only payment options. This can help keep costs lower until the repayment period, when you’ll need to make interest and principal payments. Plus, you’ll only make payments on the balance used.

Scenarios Where Cash-Out Refi Is Better

Cash-out refinances can make sense in these scenarios:

•   You need a large sum of money: If there’s a need for a large sum of money, or if the funds can be used as a tool to improve your financial situation on the whole, a cash-out refinance can make sense.

•   You can get a lower mortgage rate than you currently have: If refinancing can allow you to secure a lower interest rate than your current mortgage offers, then that could be a better option than taking on a second mortgage, as you would with a home equity loan or HELOC. If interest rates have risen since you first took out your loan, however, a cash-out refi could mean paying more in interest over the life of the loan.

•   You want just one monthly payment: Because a cash-out refinance replaces your existing mortgage, you won’t be adding a second monthly mortgage payment to the mix. This means you’ll have only one monthly payment to stay on top of.

•   You have a lower credit score but still want to tap your home equity: In general, it’s easier to qualify for a cash-out refinance vs. HELOC or home equity loan since it’s replacing your primary mortgage.

The Takeaway

Cash-out refinancing, HELOCs, and home equity loans each have their place in a borrower’s toolbox. All three options give borrowers the ability to turn their home equity into cash, which can make it possible to achieve certain goals, consolidate debt, and improve their overall financial situation.

Homeowners interested in tapping into their home equity may consider getting a HELOC or taking a cash-out refinance with SoFi. Qualifying borrowers can secure competitive rates, and Mortgage Loan Officers are available to walk borrowers through the entire process.

Learn more about SoFi’s competitive cash-out refinancing and HELOC options. Potential borrowers can find out if they pre-qualify in just a few minutes.

FAQ

Can you take out a HELOC and cash-out refi?

If you qualify, it is possible to get both a HELOC and cash-out refinance. Qualified borrowers can use their cash-out refinance to help repay their HELOC.

Is it easier to qualify for a HELOC or cash-out refi?

It is generally easier to qualify for a cash-out refinance. This is because the cash-out refi assumes the place of the primary mortgage, whereas a HELOC is a second mortgage.

Can you borrow more with a HELOC or cash-out refi?

Ultimately, the amount you can borrow with either a cash-out refi or HELOC will depend on how much equity you have in your home. That being said, a HELOC can offer a slightly higher borrowing limit than a cash-out refi, at 85% of a home’s equity as opposed to a top limit of 80% for a cash-out refinance.

Are HELOCs or cash-out refi tax deductible?

Interest on your cash-out refinance or HELOC can be tax deductible so long as you use the funds for capital home improvements. This includes projects like remodeling and renovating.

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SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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If you’re looking to reduce the amount of income tax you’ll need to pay, there are numerous strategies to consider. Familiar moves include contributing to tax-deferred retirement and health-spending accounts, deducting certain taxes and interest, and making charitable donations. More complex maneuvers include timing investments to offset gains with losses.

Because each person’s situation is unique, be sure to check with your tax accountant to find out how a potential strategy might work for you. Note that some of the strategies included in this guide have income limits.

Keep reading to see how many of these 25 tactics you can implement.

25 Ways to Lower Your Taxable Income

As you look through this list of 25 ideas on how to pay less in taxes, you’ll note that some are broad, advising how to reduce either W-2 taxable income or self-employment income. Meanwhile, others are more targeted — for instance, applying only to the self-employed. Keep track of ideas that pertain to your situation, so you can explore them further.

1. Contribute to a Retirement Account

Many IRA contributions are tax deductible. If you’re covered by a plan at work, you can contribute up to $23,000 to a 401(k) plan in 2024, and an additional $7,500 if you’re over 50. You can also contribute $7,000 to an IRA ($8,000 if you’re over 50), though your deduction may be limited depending on income and other factors.

Self-employed individuals can contribute between 25% and 100% of net earnings from self-employment, up to $69,000 for 2024. Plans available to the self-employed include the Simplified Employee Pension (SEP) plan, solo-401(k), and Savings Incentive Match Plan for Employees (SIMPLE IRA).

2. Open a Health Savings Account

A health savings account (HSA) allows you to deposit money on a pre-tax basis. Contribution limits depend on your health plan, age, and other factors, but most individuals can contribute $4,150 for 2024.

Funds can be used to pay for qualified medical expenses or rolled over year to year. You must have a high deductible health plan (HDHP) to contribute to an HSA.

3. Check for Flexible Spending Accounts at Work

In lieu of an HSA, you can contribute up to $3,200 in pre-tax dollars to a flexible spending account (FSA). FSAs allow people with a health plan at work to deposit money and then use it to pay for qualifying health care costs. Unlike HSAs, FSAs don’t require an HDHP to qualify. The downside: Only a small portion of funds may be rolled over to the following year.

4. Business Tax Deductions

The IRS guidelines around business deductions change frequently, so it’s wise to watch out for their announcements throughout the year. Some business expenses apply only to self-employed people.

5. Home Office Deduction

When a self-employed person regularly uses a specific area of their home for business purposes, they may qualify to deduct costs associated with that part of the house. The home office deduction can be calculated in two ways (regular or simplified) up to the current gross income limitation. For more information, search for “IRS publication 587.”


💡 Quick Tip: Online tools make tracking your spending a breeze: You can easily set up budgets, then get instant updates on your progress, spot upcoming bills, analyze your spending habits, and more.

6. Rent Out Your Home for Business Meetings

If you’re self-employed, you can also rent out your home for business events and meetings, collect the income — and not have to pay income taxes on that rental income. To learn specifics, visit https://www.irs.gov/pub/irs-drop/rp-13-13.pdf.

7. Write Off Business Travel Expenses

Travel expenses, as defined by the IRS, are the “ordinary and necessary expenses of traveling away from home for your business, profession, or job. You can’t deduct expenses that are lavish or extravagant, or that are for personal purposes.” For IRS guidance for both W-2 employees and the self-employed, go to https://www.irs.gov/taxtopics/tc511.

8. Deduct Half of Your Self-Employment Taxes

When calculating your adjusted gross income (AGI) as a self-employed person, using Form 1040 or Form 1040-SR, you can deduct half the amount of your self-employment tax. The 2024 self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare, based on your net earnings.

9. Get a Credit for Higher Education

This tax credit can go up to $2,500 based on tuition costs along with what you paid in certain fees and for course materials. As a first step, income tax owed is reduced dollar for dollar up to your limit. Then, if your tax credit is more than what you owe, you may be able to get up to $1,000 in a refund.

10. Itemize State Sales Tax

Currently, you can deduct a total of $10,000 for itemized state and local income taxes, sales taxes, and property taxes when you use Form 1040 or 1040-SR. If married but filing separately, the total is $5,000 per person. The IRS provides a calculator that you can use to figure out your deduction at https://apps.irs.gov/app/stdc/.

11. Make Charitable Donations

A taxpayer can typically deduct up to 60% of their AGI to qualified charities. But starting with contributions made in 2020, the IRS implemented a temporary suspension on limits. This means that a person can make qualified charitable contributions up to 100% of their AGI.

12. Adjust Your Basis for Capital Gains Tax

If you sell an asset, including but not limited to investments, a capital gains tax is levied on the difference between the purchase price and what it sells for. The adjusted basis also takes into account the costs of capital improvements made, minus decreases such as casualty losses. For more on the topic when selling a home, search for “IRS publication 523.”

Recommended: Should I Sell My House Now or Wait?

13. Avoid Capital Gains Tax by Donating Stock

You may be able to avoid paying capital gains tax if you transfer the ownership of your appreciated stock (held for more than one year). This is something that needs to be handled in exactly the right way; your tax accountant can help.

14. Invest in Qualified Opportunity Funds

If you invest in property through a Qualified Opportunity Fund, the IRS states that you can temporarily defer paying taxes on the gains. Taxes can be deferred (not reduced or canceled) up until December 31, 2026, or until an inclusion event occurs earlier than that date. This is a complex strategy and, again, you may want to get professional advice.

15. Claim Deductions for Military Members

You may be able to deduct moving expenses if you’re a member of the military on active duty who relocated because of a military order and permanent change of location. In this case, you can potentially deduct your unreimbursed moving expenses as well as those for your spouse and dependents. You can calculate relevant expenses on “IRS form 3903, Moving Expenses.”

16. Enroll in an Employee Stock Purchasing Program

In an employee stock purchase plan (ESPP), an employee who works at a company that offers this program can buy company stock at a discount. The company takes out money through payroll deductions and, on the designated purchase date, buys stock for participating employees. Note that only qualified plans have potential tax benefits.

17. Deduct the Student Loan Interest You’ve Paid

You may qualify to deduct student loan interest. Annual deduction amounts are the lesser between the amount of interest paid and $2,500. This deduction is lowered and eliminated when your modified adjusted gross income (MAGI) reaches a certain limit based on your filing status.

18. Sell Your Losing Stocks to Claim Capital Loss Carryover

If you sell stock at less than the purchase price, you’ve experienced a capital loss. You can use that loss to offset any capital gains that year. If you’ve lost more than you’ve gained, this can reduce your taxable income, which could reduce what you owe up to $3,000 for individuals and married couples, and $1,500 for someone married who filed separately.

Recommended: Tax Loss Carryforward

19. Deduct Mortgage Interest

You can deduct the money you paid on mortgage interest on the first $750,000 (or $375,000 if married, filing separately) of mortgage debt you owe. Higher limits exist ($1,000,000/$500,000) if the debt was taken on before December 16, 2017.

20. Deduct Medical Expenses

Under certain circumstances, you can deduct medical and dental expenses for yourself, your spouse, and dependents. You’ll need to itemize on your tax return and can only deduct qualifying expenses that exceed 7.5% of your AGI.

21. Delay IRA Withdrawal Upon Retirement

You can delay IRA withdrawals so that you don’t have more taxable income when you’re a high earner. For example, if you reach the age of 70 ½ in 2022 or later, you can wait until April 1 after you reach the age of 72.

22. Ask Your Employer to Defer Income

You pay income tax in the year the income is received. Although there are reasons why employers typically can’t postpone providing paychecks, they may be able to delay a bonus to the following year as long as this is standard practice for them. If self-employed, you can delay sending your end-of-year invoices to bump December payments to the following calendar year.

23. Open a 529 Plan for Education

A 529 plan allows you to save for future educational expenses. Although the contributions themselves aren’t deductible, interest that accrues in the account is tax-free, federally, as well as being tax-free in many states. In other words, when the money is withdrawn to pay college expenses, it is not taxed.

24. Buy Tax-Exempt Bonds

Interest you receive on muni bonds, for example, is not federally taxed (although there may be state and/or local taxes). These are typically very safe investments, although the interest rates may not be what you want.

25. Time Your Investment Gains or Losses

Known as tax loss harvesting, this strategy takes planning because you’ll want to ensure that any investment gains can be offset, as much as possible, by tax losses. So you may decide, as just one example, to hold on to a stock that’s lost significant value — selling it at a time when it can offset a stock sale with a sizable gain.


💡 Quick Tip: Income, expenses, and life circumstances can change. Consider reviewing your budget a few times a year and making any adjustments if needed.

The Takeaway

High earners looking to reduce taxable income have many avenues to explore — some you’ve likely heard of, with others perhaps new to you. For instance, investors may be able to take advantage of tax loss harvesting, tax loss carryover, or tax efficient investing. Consult your tax accountant about your specific situation. And to take advantage of tax reduction opportunities, it’s important to keep careful track of your financial transactions.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

See exactly how your money comes and goes at a glance.

FAQ

How can I lower my taxable income?

If you’re wondering how to reduce your taxable income, there are numerous strategies that might work for your situation. A good place to start: Contribute to a retirement account, open a health savings account, and learn which taxes and interest you can deduct. Talk to your tax accountant about specific questions you may have.

What are the tax loopholes for the rich?

If you’re looking to reduce your taxable income, consider making charitable donations and investigating investment strategies that offset gains with losses.

Do 401(k) contributions reduce taxable income?

Said another way, are IRA contributions tax deductible? Retirements typically offer some tax benefits with specifics varying based on the type of retirement account. Traditional IRAs have different rules, for example, than Roth IRAs.

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Photo credit: iStock/Petar Chernaev

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Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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