Home Equity Loans

Besides the obvious advantages of owning a home, there are several other benefits that might not be so well known. Owning a home means that you have a roof over your head and something to leave your children or grandchildren, and it is a large part of the American dream. Most home buyers use a mortgage loan to buy their homes. Mortgage loans are expensive and have long repayment periods, but they are a good solution for those who can’t afford to buy a home with cash. Essentially, during this period, both the lender and the borrower own parts of the home, until the mortgage is paid off. The borrower’s share of the property is represented by the equity, which is the difference between what the home is worth and what the homeowner owes on it.

Home Equity

Most homeowners don’t actually own their homes outright until the mortgage loan is paid off. While the borrower keeps making mortgage payments, the equity in the home keeps increasing, getting the borrower closer and closer to truly owning the home. Home equity can be built in two ways.

One is by making a down payment, which will ensure that you have some equity in the home as soon as you purchase it. Most mortgage loans require a 10 to 20 percent down payment, which will represent the initial equity in your home. You can also make a larger down payment, which will make your initial equity larger, and also give you other benefits, like a shorter repayment period, smaller monthly mortgage payments, a reduced interest rate, or the ability to qualify for a larger loan amount. The other way in which equity is built is through your monthly mortgage payments. A part of each payment goes towards the interest, while the other goes towards the principal, which is the actual money that you borrowed from your lender. The equity in your home will increase slowly in the beginning of the repayment period because most of the money will go towards paying the interest, but will pick up later on.

The problem with home equity is that it is strongly influenced by the market value of your home: if home prices go down, the equity in your home decreases, and the other way around. For example, if your $500,000 home increases in value to $550,000, the extra $50,000 will be added to your equity. However, if your home’s value drops to $450,000, for example, the $50,000 difference will be taken out of your equity.

The Home Equity Loan

When taking out a home equity loan, the borrower uses the equity in his or her home as collateral. Home equity loans are typically used for large expenses such as home improvements or repairs, paying medical costs and school tuition. Because it is secured against your home, the home equity loan is often times called a second mortgage, and can provide access to larger amounts of money when needed. Home equity loans can be very beneficial when used in the following situations:

  • Paying off credit cards. Home equity loans tend to have higher interest rates, but their interest rates will almost always be lower than the interest rates of credit cards. Paying off credit cards with a home equity loan allows you to repay the debt at a lower interest rate over the course of a few years.
  • Paying off non-deductible loans. Loans taken out for purchases such as cars don’t feature a tax-deductible interest. Paying off a car loan with a home equity loan that has a deductible interest rate can save you a lot of money.
  • Making home improvements or repairs. Home equity loans can be used to renovate or make improvements to your home, and the interest, up to $1 million, is tax-deductible, making it a better choice than using a high interest rate credit card or other type of loan.
  • Paying medical bills or college tuition. Having equity in your home can be of great help if you, or a family member, have large medical bills. Also, the interest on a home equity loan used for other purposes than home improvement is deductible up to $100,000, making it a wise choice for those who wish to pay their own or they children’s college tuition.

Home equity loans can be used to finance a variety of things, and also have other advantages. A large advantage is that home equity loans, unlike adjustable-rate mortgages and home equity lines of credit, have a fixed interest rate. This means that, no matter how the market fluctuates, you will pay the same interest rate for the duration of the loan, eliminating any unpleasant surprises that would arise if the interest rate suddenly increased. Another advantage is that, with a home equity loan, you have quick access to money, without having to take it out of your retirement or savings accounts.

Home equity loans are a great perk that comes with being a homeowner. Being able to access the equity in your home for renovations or paying any large bills that you might have is another reason why owning your own home is much better than renting. If you are a homeowner who needs money, you should look at home equity loans before opening a credit card or taking out a loan with a larger interest rate and less advantages.