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More and more lenders are offering home equity lines of credit. By using the equity in your home, you may qualify for a sizable amount of credit, available for use when and how you please, at an interest rate that is relatively low. You would be making payments only on the amount of the credit line that you have used.
Loan or Line of Credit?
This concept is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer's largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills and not for day-to-day expenses.
With a home equity line, you will be approved for a specific amount of credit--your credit limit, the maximum amount you may borrow at any one time under the plan. Many lenders set the credit limit on a home equity line by taking a percentage (say, 75 percent) of the home's appraised value and subtracting from that the balance owed on the existing mortgage. If the home appraises at, for example, $200,000 the lender will take 75% of that figure - $150,000 - and deduct from it what you owe on your mortgage. If you still owe $100,000 on the house, the available home equity line of credit would be $50,000.
A home equity loan is basically a second mortgage. Using the same mathematical formula, you would be taking out a second loan on the house of $50,000. Because it is a straightforward loan, you would be allowed the same tax deductions on a home loan that you are getting on your principal mortgage. Under some circumstances, the interest paid on a line of credit is also tax deductible. With a home equity loan, obviously the tax break is going to be larger but so is the monthly payment.
What Type of Loan?
Many people have taken advantage of the rapid rise in home values paired with record low interest rates to jump at home equity loans or lines of credit. Both of those factors are showing some signs of changing for the less attractive. Accordingly, it’s important to consider what type of home equity loan you should take out. If you have every intention of paying it off in relatively short order OR if you believe the low interest rates are going to stay low, an adjustable rate mortgage probably makes sense. If you think you’re going to be paying on this loan for a period of more than five years, look towards a fixed rate loan.
There are some extremely low rate loans out there that are relatively short term, with balloon payments at the end of the note. Unless you are relatively certain of a stable household income and have incorporated that balloon payment into your planning, stay away from this type of gamble. It’s not worth betting the attractive low interest rate against the possibility that adverse circumstances might make it impossible to make that balloon payment or refinance it. If that occurs, you’re going to lose your home.
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