Using Home Equity
What are home equity loans and lines of credit?
A home equity loan is a second mortgage, or second lien on your home. As with a cash-out refinancing, you can use a home equity loan to borrow an amount equal to the equity in your home. Home equity loans are good tools if you know exactly how much you want to borrow. As with mortgages, you pay them off according to a monthly payment schedule.
Home equity loans have many advantages over cash-out refinancings. Home equity loans cost less and close faster than a refinancing, usually in only a few days. You borrow money through a home equity loan for a shorter term-usually 5 to 15 years-than a refinanced mortgage, which reduces your interest costs.
However, home equity loans usually charge higher interest rates than refinanced mortgages. But if you already have a low rate on your mortgage and ca not refinance any lower, then it would make more sense to take out a home equity loan than refinance your entire mortgage at a higher rate.
Home equity lines of credit work something like a credit card. A line of credit is based on the amount of equity in your home. When you borrow it and pay it back, your credit revolves and you can borrow it again. You only pay interest on the amount that is borrowed at any given time. Lines of credit can be accessed by writing special checks or using a credit card tied to the account.
If you borrow small amounts and pay them back quickly, lines of credit can be cheaper than a home equity loan.
With both home equity loans and lines of credit, if you tap less than 100 percent of the equity in your home, the interest is usually tax-deductible.
Can I borrow more equity than I have in my home?
Yes. There are loan products that allow you to borrow more than 100 percent of the value of your home, based on the assumption that your home will go up in value to the amount borrowed. These products charge a very high interest rate because they carry great risk.
What are appropriate uses of home equity?
When you convert home equity to cash, either through a cash-out refinancing or a home equity loan or line of credit, you need to carefully consider how you plan to use the money.
Spending the money on something of enduring value, especially if it could increase the value of your property, would be an appropriate use of the equity. Remodeling or expanding your home, for example. A child's college tuition or starting a business may be other good reasons to tap home equity because they are investments in the future that have real payoffs. Some people use home equity for financial and medical emergencies.
While paying off high-interest credit card debt is a suitable use of home equity, you have to make sure you change your spending habits so you do not rack up big charges on your credit cards again. In that case, you would be left with no more home equity and a mountain of unsecured debt.