Home Equity

Home equity loans for the uninitiated

You see it everywhere...home equity loans at what appear to be really good interest rates. And you might know that the interest on most home equity loans is often tax deductible. So a home equity loan is a really good thing? Right?

Well, maybe.

What is a home equity loan?

Many people don´t have any idea what a home equity loan is or whether is would really benefit them. Many of us are pretty naive about the costs associated with borrowing money. If you have a credit card and carry a balance of $1000 for one year, given an 18% interest rate, that privilege will cost you $180. In fact, most of us would probably think of getting a personal loan or using our credit cards if we needed to meet an unexpected expense instead of tapping our home equity.

Home equity in its simplest terms is the investment in your home that is yours after any existing liens, mortgages, and loans are subtracted from it. If your home is worth $200,000 according to a bank appraisal and would likely sell for that amount in the current market and you owe $100,000 on a current mortgage, then your equity is about $100,000.

A home equity loan may be interchangeably referred to as a second mortgage. The difference is that a home with an existing mortgage may qualify for a home equity loan, but that loan may be referred to as a second mortgage. A home that is owned free and clear, obviously qualifies for a home equity loan, but because there is no existing mortgage, it´s referred to as just a home equity loan. If the homeowner sells, both the first and second mortgages must be paid off at the time of the sale.

Make your home equity work for you

If you have equity in your home, then there are several situations in which it could be a smart move to use your equity to simplify your finances and save some cash.

If your home needs a new roof, kitchen redo, or an extra bathroom, you can pay for the improvements with a home equity loan. There are several advantages to using an equity loan this way. Maintenance and enhancements that preserve the integrity of the building or are highly desirable can increase your home equity while you enjoy the convenience and pleasure of the improvements. In most regions of the U.S., adding a bathroom or remodeling the kitchen can result in as much as 110% return on investment if you were to sell. Landscaping is another home improvement that garners a good return. And unlike a credit account or personal loan, the interest on the home equity loan is tax deductible. You´ll benefit by paying a lower interest rate and getting a tax deduction. What´s not to love?

Another way to make your home equity work for you is to consolidate your existing debt in a home equity loan. If you have an auto loan, several credit card debts, and need to replace the washer, you can get a home equity loan to combine all those bills into a single payment at a lower interest rate and take the tax deduction on the interest.

Some people have found that taking a home equity loan allows them a source of funding for education expense for themselves or their children. Investing in your children can get them educated and employable faster than might otherwise occur, but this depends on the situation, the school, and the kid. And in the current economic climate, retraining oneself may be necessary too. To maximize the benefit and reduce financial exposure, check scholarship and grant programs, training opportunities, but consider your home equity a resource that can be used on a contingency basis after other options have been fully investigated.

When to back away slowly

A home equity loan or second mortgage can solve a host of financial problems and make your life easier and confer some benefit, but it isn´t a silver bullet. A home equity loan is still a loan and needs to be paid back. It can be very tempting to borrow against your equity and find that you´ve tapped yourself out, have no more home equity, and then have difficulty meeting your obligations.

As with any loan, there are companies that zero in on seniors and those with poor credit ratings. They provide loans based only on the equity of your home and not your ability to pay. For an older person on a fixed income that could mean stripping their home equity and losing their home. Some lenders may encourage you to refinance over and over. Each time, you pay fees that are rolled into your debt and your term is extended. There are other equally dangerous practices, some of which are illegal, but for homeowners who aren´t that well versed in the subtleties of home finance, it can be easy to get snookered.

The Federal Trade Commission suggests that if you are considering a home equity loan, that you proceed with caution. You can lose your home if you aren´t careful. To protect yourself, keep the following tips in mind:

Whatever you decide, keep your perspective. A home equity loan can make you feel like you have more money than you really do. It´s not uncommon for people to take out a home equity loan or a second mortgage,then spend beyond their means. They end up losing their homes because they´ve overextended themselves. There´s a snowball effect, and once you start down that road, you can quickly get yourself into trouble. A conservative rule of thumb might be to avoid borrowing for consumption like vacations that can´t give you any return on the investment.

Get several different estimates, loan terms, and interest rates from different lenders. If you are not a financial wizard, ask your lawyer or financial advisor if a home equity loan is in your best interests. If you don´t have that type of professional support available, contact the Federal Trade Commission at 1-877-FTC-HELP (1-877-382-4357). They can make suggestions that will point you in the right direction.

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