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For many people, a home equity loan meets the necessary requirements for borrowing money. It offers several important factors--ease of obtaining the funds, a reasonable interest rate on the loan, an acceptable repayment schedule, and generally the interest can be written off on your taxes. Although no one likes to go into debt or owe money, there are times when it is convenient, or even necessary, to borrow money. The key is to find a way not only to get the cash you need, but also to get it on terms that work to your best advantage. A home equity loan can often be tailored to meet your individual needs.
Why do people get home equity loans? Debt consolidation is a very common use of a home equity loan. Home improvement is also a common reason. Although these are the most common reasons for a home equity loan, this type of loan allows you to use the money you've accumulated as equity in your home for anything you want--a car, college tuition, even a vacation or other things.
There are two basic types of home equity loans.
1. A home equity line of credit (HELOC) allows you to borrow the difference between what your property is worth and what you still owe on the mortgage. By using the equity in your home, you may qualify for a sizable amount of credit, available for use when and how you please. Typically the interest rate on these loans is based on the prime rate plus a margin.
In determining your actual credit line, the lender also will consider your ability to repay, by looking at your income, debts, and other financial obligations, as well as your credit history. If you borrow $40,000 and pay it back, you can borrow that money again. A home equity line is a form of revolving credit in which your home serves as collateral. The funds are often accessible through an account where you write checks that become a series of "mini-loans" against your equity. When you repay the "mini-loans" plus interest, you can use the equity over and over again.
Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home. These can include an appraisal fee; an application fee; closing costs such as attorney fees, title search, mortgage preparation fees, and title insurance; plan fees such as yearly maintenance fees; and perhaps a transaction fee every time you draw on the credit line.
2. The second kind of home equity loan is a regular, fixed rate second mortgage. You borrow the entire amount at once and the payments are amortized over 15 to 20 years. You have a set payment every month until you pay the loan off.
In terms of getting money out of your house and into your pocket, the decision about whether it's better to take out a line of credit or just refinance depends on the individual family situation. Usually the interest rate on refinancing your home is lower than the interest rate on a second mortgage loan. On a line of credit, risks are higher for the lender, so the lender charges a higher rate.
If you have to borrow money, one big advantage of both types of home equity loans is that the interest on them is typically tax deductible. According to Internal Revenue Service Publication 936 `Home Mortgage Interest Deduction', the total home equity debt on your main home and second home is limited to the smaller of the following: $100,000 ($50,000 if married filing separately) or the total of each home's fair market value. Consult your tax advisor for your particular circumstances.
If you have additional questions about home equity loans where you live, you should call a lender in your area. It just could be the first step to getting a loan tailored to your individual needs. As in the case of other loans, always do comparison shopping in order to get the best rate and terms possible.
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