Home Equity Loans
A home equity loan, often called a second mortgage, is borrowing against the equity of your home. The equity is the calculated value of your home less any current mortgages or debts. The danger of such a loan, as with any home loan, is that your house becomes the collateral and in cases of default you could lose it. However, a home equity loan is superior to other types of borrowing, in that the interest rate will, in most cases, be significantly lower. The interest that you pay on the loan is also tax deductible. A tax advisor will be able to tell you exactly how much money you will save, but generally speaking, the interest that you pay, up to $100,000, will be subtracted from your taxable income at the close of the fiscal year.
Your new interest rate will be lower than other types of high-interest borrowing but still higher than a regular mortgage, because the lender assumes more risk with a home equity loan. If you decide to go with this type of home loan make sure to go with the shortest possible term (the highest monthly payments that you can afford) in order to pay it off as soon as possible, thereby saving yourself thousands of dollars in interest.
Because a home equity loan decreases the equity of your home, the smartest use of the money would be to improve upon your financial situation in some way, such as using it for education purposes, debt consolidation or financing a business. Making renovations or repairs, anything that increases the market value of your house, is another smart way to use the funds because this in turn can increase the equity of the home if the market value is pushed up beyond the loan value.
Types of Home Equity Loans:
- Customary Home Equity Loan: Also called a second mortgage loan, a term loan, or a closed-end loan, is the standard equity loan that acts the most like a regular mortgage loan. The borrower receives a one-time large sum of money that is paid back over the course of the term of loan, which can range from 10-30 years.
- Home Equity Line of Credit (HELOC): This program is used as a revolving line of credit, very similar to that of a credit card, where you can withdraw the necessary funds at your convenience. The great thing about a HELOC is that you only pay interest on the amount of money that you have used. That way, you can borrow a certain amount, pay it off, and then borrow again, all without having to take out a new loan.
If you are thinking about taking out a home equity loan to make repairs or additions, please visit our Home Improvement page.