Tracing rules
The character of interest (deductible business interest, deductible investment interest, non-deductible personal interest, deductible mortgage interest) depends on what the borrowed funds are spent on, not on what the loan is called or what collateral secures it. A home equity loan whose proceeds bought business equipment is business interest; a business line of credit whose proceeds paid for a personal vacation is personal interest.
Practical guidance
Borrow into a separate, dedicated account and trace the spending from that account. If you must borrow into a commingled account, spend the borrowed funds within 30 days to avoid the "ordering rules" that can re-allocate the proceeds to subsequent personal spending.
Allocation when proceeds are mixed
When proceeds are spent partly on business and partly on personal items, interest is allocated based on the spending split at the time of the spend. Subsequent repayments do not re-characterize old interest — once allocated, the interest character sticks.
Interest paid to family
Interest paid to a related party (family, controlled entity) is deductible if the loan is bona fide — written terms, market rate, actual repayments. The recipient must report the interest as income. Sham loans without economic substance are recharacterized as gifts or capital contributions.
Where it goes
Schedule C line 16a ("Mortgage interest" — only for business-property mortgages paid to a financial institution) and 16b ("Other interest" — everything else, including business credit cards, business term loans, equipment financing). For sole proprietors, business interest does NOT go on Schedule A.
Worked example with numbers
Consider a sole prop with $100,000 in gross receipts and $30,000 in legitimate Schedule C deductions, including this category. Each additional $1,000 of qualifying expense reduces Schedule C net profit by $1,000, which reduces self-employment tax by approximately $1,000 × 92.35% × 15.3% ≈ $141, and reduces income tax by $1,000 × marginal rate. At a 22% federal marginal rate, the combined federal tax savings on each additional $1,000 of legitimate deduction is roughly $361, and state savings sit on top of that. The math is why disciplined categorization throughout the year pays for itself.