What You Need to Know About Student Loan Interest
If you have borrowed funds to finance your college education or that of your spouse or children, it is important that you understand that the student loan interest deduction is not limited to the interest paid on government student loans. In fact, virtually any loan interest will qualify as long as the loan proceeds are used solely for qualified higher-education expenses (that is, it is a sole-purpose loan). However, the maximum interest that is deductible each year is $2,500. Thus, in addition to government student loans, home equity lines of credit, personal loans from unrelated parties, and even credit cards can be used if they otherwise qualify. Pension plan loans and loans from related parties do not qualify.
Example #1 – Jack takes out an equity line of credit on his home and borrows $30,000 to finance a solar electric installation on his home and $10,000 to pay his daughter’s qualified education expenses. Because this loan is not used for a single purpose (he used it to borrow funds for more than education), he cannot deduct a portion of the interest as above-the-line education loan interest. However, Jack can still deduct the prorated interest on the solar installation as home-acquisition debt if the total debt does not exceed the acquisition debt limits. If Jack had only used the loan to pay for qualified education expenses, then up to $2,500 of the loan interest could have been deducted as above-the-line student loan interest.
Example #2 – Mark has a Visa card that he uses for a variety of purposes, and he also uses it to pay his daughter’s qualified education expenses. Because the credit card is not used exclusively to pay for qualified education expenses, none of the interest will qualify as student loan interest. However, if Jack had only used the credit card to pay for qualified education expenses, then up to $2,500 of the credit card interest could have been deducted as above-the-line student loan interest. Caution: Although we use a credit card as an example of an alternate student loan, it is not practical because of the high-interest rates.
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If a loan is not subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the federal, state, or local government or an eligible educational institution, a payee (the lender) must request a certification from the payer (the borrower) that the loan will be used solely to pay for qualified higher-education expenses.