A Powerful Financial Tool
Home Equity Loans allow homeowners to use their home's equity (home value minus your existing mortgage) as collateral for additional borrowing. These loans typically offer attractive rates, convenience and often tax benefits. Though, there are risks and costs with this strategy.
Benefits of Home Equity Loans
- Convenience - The application process is usually easy and approval is often fast. Once approved, you do not have to borrow it all at once as your commitment acts as a line of credit.
- Interest rates - Interest rates on home equity loans are usually greater than those on first mortgages but less than those on credit cards. Money can often be saved by using the proceeds of a home equity loan to pay off credit cards.
- Flexible uses - Even though you are borrowing against your house, there is no requirement to use the money on your house. A home equity loan can be used for vacation, auto purchases or funding your child's education.
- Tax benefits - For individuals that itemize their tax deductions, the interest paid on home equity loans can help save some income tax. Consult with your tax advisor.
How do they work?
The amount an institution will lend depends on equity in your home and your other credit characteristics. Often they will lend up to an amount so the total debt against your home (including first mortgage and other loans with your home as collateral) is less than 80% of the current value of your home. Interest rates are usually variable and tied to a published index, such as the prime rate. Check out the rate details - Be wary of institutions that offer low initial "teaser" rates and then raise the rates shortly thereafter.
Usually, you repay the loan in regular installments with minimum repayments required. With some home equity loans, the minimum payments may only be the interest on the loan and you may be required to repay the loan at a certain date. You need to read the details carefully.
Beware of the risks
Be careful and make a wise decision for your situation and finances. Even though there are many attractive benefits, these types of loans are like all loans - you pay interest and it must be paid off. Loan documents can be confusing - read and understand all the details before signing. Do not let a quick, easy application and approval process sidetrack you from doing your proper due diligence.