There is a misconception about borrowing and rental properties that only interest on debt secured by the property itself is tax-deductible. It is actually the use of borrowed funds that determines tax deductibility. If you use a HELOC on your home to buy a property you plan to rent out, the interest on that borrowed HELOC balance is tax-deductible. 

Extending this concept, if you borrowed against the rental property in the future—whether using a mortgage or a HELOC on it—that interest is not automatically tax-deductible. If the borrowed funds were used for a renovation on the rental, to buy another rental property, or for some other eligible business or investment purpose, the interest may then be tax-deductible. But if you borrowed the funds to purchase a car, the resulting interest would not be tax-deductible, despite being borrowed against a rental property. 

If this second property is a personal-use property—like a cottage or ski chalet—the interest would not be tax-deductible unless you are also renting it out. 

Compartmentalizing your finances 

One reason to get a new mortgage on the property is to keep your finances separate. Some people would get stressed seeing a line-of-credit balance on their primary residence and would be better able to compartmentalize the debt if it were secured by the new property itself. 

Thus, compartmentalization may have a psychological benefit by pairing the debt with the asset itself. 

Your borrowing capacity has limits 

If your bank approved you for a $400,000 HELOC, Caren, that probably means it would approve you for more if you borrowed against the second property’s value. 

The HELOC has limits based on your own property’s value, as well as your income. A mortgage on the new property could be higher, especially if there will be rental income, which would increase your total income-earning ability. 

The bottom line

When buying a second property, how you use it will determine the tax implications for the borrowed funds, if any.