Home Equity Loan Basics
Written by Daphne Tai, Kasey Ng   


A home equity loan, also known as a second loan, allows homeowners to borrow money by leveraging the equity in their homes. In other words, a home equity loan is a type of loan in which the borrower uses the equity in their home as collateral. Borrowers who want to borrow a relatively large amount of money or who don’t have good credit often find the home equity loan to be attractive.


Home Equity Loans Attractiveness
  • They typically have a lower interest rate/APR
     
  • They are easier to qualify for if borrowers have bad credit
     
  • Payments on a home equity loan may be tax deductible
     
  • Borrowers can get relatively large loans

Because home equity loans are secured by one’s personal residence, lenders consider them as secure as primary mortgages. Although equity rates are higher than rates on primary mortgages, they usually have lower rates than credit cards and auto loans. The reasoning behind this is that equity loans involve collateral, and credit card debt does not.


Tax Deductibility

Home equity loans are attractive financing options because the interest payments from this second mortgage are tax deductible. Taxpayers can claim a deduction on interest paid on a loan that is secured by their first or second home. In the case of the Home Equity Loan, borrowers can deduct the interest on the first $100,000 of a home equity loan. If the borrower uses the Home Equity Loan for home improvement, then the tax deduction can go up to $1,000,000.

The interest on Home Equity Loan can be deductible if the following conditions are met:
  • You file Form 1040 and itemize deductions on Schedule A (Form 1040).
     
  • You are legally liable for the loan.
     
  • There is a true debtor-creditor relationship between you and the lender.
     
  • The mortgage is a secured debt on a qualified home in which you have an ownership interest.
For the Alternative Minimum Tax (AMT), the interest paid on the Home Equity Loan can be tax deductible only if the loan is used on home improvement.


Reasons to Borrow

The main point of having a home equity loan is to get cash. But people have different uses of this huge amount of money. Here are some common home equity loan uses:
  • Remodel or renovate the house
  • Pay for a family member’s college education
  • Finance the purchase of a second home
  • Consolidate high-interest debt
One way to use home equity loan is for home improvement. Many homeowners decide to get a home equity loan when they want to make upgrades and repair their house. This is an efficient use of equity loan – deploying it in a way as to make the house more valuable.

Some people believe that the easiest way to pay tuition and fees for a child’s private school or college is to turn to home equity. This is especially suitable for families whose incomes are too high to qualify for student loans or financial aids. Sometimes home equity loans are also useful when people deal with unexpected medical bills or need to cover the cost of a single, expensive purchase.

Debt consolidation is another main reason why people choose to take out a home equity loan. Those who have accumulated a lot of credit card debts may turn to a home equity to ease the burden by using their equity to consolidate debt into one large loan, and one monthly payment. Because credit card interest rates are usually more than 10 percentage points higher than rates on home equity loans, choosing a home equity loan can reduce monthly interest charges.

Disclaimer: Please understand that debt consolidation does not mean that credit cards are now debt free. Although we provide tip, it is important to still consult a professional.


Is a Home-Equity Loan the Right Choice for me?

A home equity loan might be the right choice for you if you plan to use the money in a lump sum for a one-time occasion. In addition, many people prefer a home equity loan since the interest rate is fixed, which means the monthly payments are fixed as well; therefore, people can plan their budget for the future.

In summary,
  • If you need the money in a lump sum rather than in several installments, a home equity loan is a right choice.
     
  • If you plan to spend this amount of money on something that lasts a long time, a home equity loan is a right choice for you. For example, people get a home equity loan for their house remodeling, buying a car, or having a new roof.
     
  • If you don’t like having a rate that would fluctuate during the loan period, getting a home equity loan reduces this risk because it has a fixed rate.
Last Updated on Wednesday, 22 December 2010 05:47