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My house is worth $500k. i owe $125k on my house. i take out a home equity loan for $200k. i use $125k to pay off my 1st morgage, and use the other 75k to buy a car.

Now how much of the home equity loan is tax deductible? and why?

It depends on how the $125k mortgage came to be in the first place.

If it was the original purchase mortgage (or a refinancing thereof), then you have again refinanced it and can deduct the interest on $125k of the $200k as home mortgage interest. Then since you have borrowed an additional $75k of equity and have no existing home equity debt, the interest on the $75k will also be deductible. You could borrow an additional $25k in home equity and still deduct the interest.

However, if you had paid off your mortgage at some point, and then subsequently borrowed the $125k, then only $100k of the $200k in new mortgage debt would have deductible interest.

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