Tapping your home equity:

In the broadest sense, equity means ownership. Equity in a home is the difference between the property's current market value (the amount it could be sold for or appraised value) and any debt or claim against it. For example, if you own a home currently valued at $300,000 but still owe $200,000 on your mortgage, your equity in the home is $100,000. Equity accumulate in two ways: Each time you make a monthly mortgage payment, the principal portion of your payment helps build up your equity, and your home appreciates in value.

For example if you paid $100,000 for your home and put down 5 %, you'd have $5,000 in equity. After 10 years of mortgage payments, you'd probably have added another $10,000 in equity by paying down your mortgage balance. However, during those 10 years, your home's value may have appreciated to $150,000. Now you have $65,000 in equity in your home ($5,000 down payment, $10,000 in mortgage balance paid and $50,000 in home appreciation). You can sell your home to tap the equity or if you don't want to sell, there are 2 main ways you can get your equity: One is to refinance and another is to get a home equity loan or a home equity line of credit.

What is refinancing?
When you refinance, you are replacing an existing mortgage with a new mortgage on the same property. There are many reasons why people refinance their mortgage. Most people refinance to get a lower interest rate, which reduces the monthly payment and often the overall cost of the mortgage. Some refinance to get a shorter term mortgage (15 year mortgage) to replace a longer term loan (30 year mortgage). While this may increase monthly payments, it will save thousands in mortgage interest. Other people seek a fixed-rate mortgage to replace their current adjustable-rate mortgage (ARM). They may do this to get what they consider a better rate or to seek a rate that is consistent over the term of the mortgage instead of changing during the term. Another reason some people consider refinancing their mortgage is to consolidate their debts. They may have a car loan, other installment loans, and credit card loans--some of which may be at very high interest rates. Others want to get money to use for home improvements or to help pay education costs. Some people may want to refinance because of divorce. They want to remove the other person's name from the mortgage papers.

Refinance doesn't come cheap. Since you are taking out a new mortgage when you refinance, you often have to pay up-front fees and closing costs again even if your mortgage is a few years old. Most of the costs are very much like the costs you paid when getting your first mortgage. These costs include an application fee, appraisal fee, and survey costs. They also include homeowner's hazard insurance, lender's attorney review fees, and title search and title insurance fees. Also involved may be home inspection fees, loan origination fees, mortgage insurance, and points.  That's especially true if you switch lender for your new loan. Sometimes you can save some refinancing costs by using the lender who holds your current mortgage. This is generally true if your lender will waive particular costs, such as the survey because it is still current.

Should you refinance?
Years ago, the rule of thumb is that it pays to refinance if you can get an interest rate at least 2 percent lower than you're currently paying on your loan. In that way, your savings would pay off the costs within two years, and you'd reap the benefits of lower rates. But the best way to figure out whether you can save money by refinancing your current mortgage is to calculate your savings using these 3 things: How much do you save in monthly payments, how much will it cost to refinance and how long you plan to stay at your home.

Even a  modest reduction in the loan rate can still trim your monthly payment. For example, if you have a $100,000 loan at 8.5%, monthly payment is about $770. If the rate were lowered to 7.5%, the monthly payment would be about $700, a savings of $70. And if it cost you $3,500 in refinancing costs, it will take 50 months ($3,500 divided by $70) to break even. So most likely you should refinance this mortgage if you are planning to stay for more than 50 months. If don't have the money to pay for associated loan costs, look for lenders that offer 'no-cost' loans. These loans will charge a slightly higher interest rate but you may still save money every month.

Home equity loans:
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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