If you are currently a homeowner, you can actually borrow against the equity you have built up in your property. Common options are to borrow via a Home Equity Loan or a Home Equity Line of Credit (HELOC). Either option is a second mortgage on the property, with the equity in your house as collateral. This means that if you default and fail to repay the loan, the ownership of your property will be transferred to the lender.
Common reasons for a second mortgage include:
Interest Rates: the interest rate of a Home Equity Loan or HELOC depends on the amount you borrow and your FICO score. You generally get lower interest rates than a credit card or conventional bank loan since you are putting your home up for the loan.
Tax Purpose: you get home mortgage interest deduction for the interest paid to this second mortgage, but you don't get any interest deduction for the interest payments to your car finances! You generally can deduct the interest on up to $100,000 of home equity borrowing. However, in the case where your level of debt is above the value of the property, you will only be allowed to deduct part of the interest.
Cashing Out: you are in your retirement and have no kids to leave your money to. You don't have to sell your home but don't want it to go waste when you go.
The table below compares the different aspects of a Home Equity Loan vs. HELOC.
Home Equity Loan
Home Equity Line of Credit (HELOC)
What You Will Get
A fixed amount of money, up to 100 percent of your equity in your home, minus any amount you owe to it. However, the ratio can go up to 125 percent of your equity under a 125 percent loan-to-value program.
A revolving credit, with a specific credit limit of up to 100 percent of the value of your home, minus any amount you owe to it.
Qualification
You typically need to provide proof of your income and home ownership, and proof that at least 20 percent of the value of your home is paid off. An appraisal is usually required as well.
You typically need to provide proof of your income, home ownership, your mortgage and how much equity you have in your home. An appraisal is usually required as well.
Your Payments
Fixed payments of interest and principal over a fixed period of time. This is just like a normal mortgage payment dependent on the interest rate structure you select (fixed or adjustable).
Minimum payments (as little as interest only) each month; eventually you have to repay the entire sum borrowed plus interest. This is just like paying your credit card.
Loan Length
This varies: the term of the mortgage can be as short as a year or as long as 30 years.
You usually have a 10 to 20 year period when you can draw on the line (up to the credit limit), after which you have a fixed period to pay off the balance plus interest.
Costs and Fees
Closing costs that are lower than for a first mortgage.
Usually no closing costs, but may have an annual fee just like a credit card.
Loan Interest
A fixed or adjustable interest rate - you can usually choose which on to go with.
The prime interest rate plus a margin (can vary from one institution to another).
Choosing Between a Home Equity Loan and a HELOC
What are you looking to do with this loan? Generally speaking, a HELOC is useful in the same way as a credit card is - for ongoing cash needs. The amount withdrawn can be any amount within your credit line, and you will pay interest only on what you borrow. A Home Equity Loan is useful for a specific, one time, lump-sum amount such as buying a car or a major home renovation, as interest rates are typically lower on a Home Equity Loan than a HELOC. See our page on Using Your Home To Finance Other Purchases for more ways to use your second mortgage.
In summary, you should pick a:
Home Equity Line of Credit if you want an extension to your current credit line and want to flexibility of spending the money or not.
Home Equity Loan if you want a one-time lump sum and the option to get a lower rate than a HELOC.
What are you looking to do with this loan? Generally speaking, a HELOC is useful in the same way as a credit card is - for ongoing cash needs. The amount withdrawn can be any amount within your credit line, and you will pay interest only on what you borrow. A Home Equity Loan is useful for a specific, one time, lump-sum amount such as buying a car or a major home renovation, as interest rates are typically lower on a Home Equity Loan than a HELOC. See our page on Using Your Home To Finance Other Purchases for more ways to use your second mortgage.
second mortgage, but you don't get any interest deduction for the interest payments to your car finances! You generally can deduct the interest on up to $100,000 of home equity borrowing. However, in the case where your level of debt is above the value of the property, you will only be allowed to deduct part of the interest.