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A home equity loan is a loan that uses your home as collateral. Your home equity
is the part of your home that you actually own and this is the guarantee for
your loan. Remember that your home equity is calculated by taking the current
value of your home and subtracting your mortgage. A lower interest rate and tax
deductions are the two major advantages home equity loans have over other types
of debt. Since a home equity loan is secured by your home, it poses less risk to
a lender than does a non-secured personal loan or credit cards - this lower risk
is passed on to you in the form of a lower interest rate.
The second major advantage is that regardless of the way a
home equity loan is used, the interest you pay on the first $100,000 you borrow
is tax deductible. Credit cards and other types of non-secured loans do not have
this tax benefit. This means that if you pay $3,000 in interest on your home
equity loan, you will reduce your taxable income by $3,000 at the end of the
year. If you use a home equity loan for home improvements or to buy another
home, you can deduct the interest paid on the first $1 million that you borrow.
The reason for this is that home improvement loans are similar to first
mortgages for tax purposes. You should consult a tax advisor about the specific
tax benefits available to you.
The biggest drawback of a home equity loan is the fact that your home is on the
line and you could lose your home if you default on your payments. When you
borrow from your home's equity you also reduce the equity or ownership you have
in your home. This means that you trade ownership or equity in your home for
cash that you will use for some some other purpose. In addition to interest you
will pay on the loan, there are also costs associated with taking out a home
equity loan - these costs are similar to the costs you paid when you bought your
home.
Two basic types of home
equity loans:
Home Equity Loan - Also called a term loan, a closed-end loan or a second
mortgage installment loan, works like a traditional loan. You receive a lump sum
payment at a fixed interest rate and you pay the money back in monthly payments
over the life of the loan. Since the interest rate on the loan is fixed, your
monthly payments will also be fixed. An example of this is a home equity loan
for $30,000 with an interest rate of 7.5% where you pay the money back in
monthly payments of $356.11 over the 10 year life of the loan.
Home Equity Line of Credit - A
home equity line of credit works like any other line of credit. You are granted
an amount you can borrow and you draw money from the account as you need it. You
pay interest on only the amount actually borrowed and the interest rate is
variable over the life of the loan. While most home equity lines of credit have
a variable interest rate, a fixed interest rate can sometimes be negotiated. A
home equity line of credit is 'revolving' meaning that you can borrow money, pay
off the borrowed money and then re-borrow that money. The money in a home equity
line of credit is accessed using specially issued checks or credit cards
Here is an example of a home equity line of credit: You are given a $20,000 home
equity line of credit. You borrow $10,000 dollars and are charged a 5% interest
rate. The interest rate for the home equity line of credit is not fixed but
varies with changes in interest rates. If you pay back $5,000 towards the
principal, you still have $15,000 in your line of credit that you can borrow
against as needed.
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What is
a reverse mortgage?
This is generally a type of loan
that is used by elderly people with lots of equity but limited
income. This loan is available to homeowners over 62, that lets
you convert your equity in your home into cash. The lender will
pay you either a lump sum amount, or make monthly payments to you.
The monthly income derived from this type of mortgage is tax
free.
The amount that you owe the lender increases over time and you
do not have to make any loan repayments while your reverse mortgage is in
effect. The loan comes due when you die or when the home is no longer your
principal residence. In most cases, the lender takes over the home, which is
generally sold to repay the loan. Be aware that if the value of the house decreases, you may be responsible for more debt than
the house is worth.
This is a very specialized type of mortgage and should not be entered into
unless you know exactly what your doing!
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<<-- Back to
Table of
Contents for Real Estate
Table of Contents:
-
Should
you buy a home?
Renting vs. Buying:
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Steps to buying a home
-
What is a
Mortgage and do you needed?
-
Different types of Mortgages
-
More Mortgage
Choices
-
0 to 5% down
with FHA and VA loans?
-
Cosigning: The Pitfalls
-
Qualifying for a
Mortgage
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How much of a
mortgage and a house can you afford?
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Finding a home with FSBOs & Real Estate Agents.
- It's closing
time: Title and the keys please!
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Tapping your home
equity: Refinancing
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Tapping your home equity: Home Equity Loans
-
Frequently
Asked Questions (FAQs) on Real Estate & Mortgages
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