If you are like many American homeowners, you may have a need for extra money in your life – to pay for a college education, healthcare bills, home renovations or something else. One of the benefits of being a homeowner is that at some point, you probably will have substantial equity in your home that you can use for whatever you like.
To access that money, you have a few options. One of the most popular is a home equity loan, as well as an equity line of credit. This article describes how a home equity loan can help you, and some considerations to think about.
#1 Pay a Low Interest Rate
One of the biggest reasons that people like to use their home equity to fund whatever major purchase they want to make is that the interest rate will be much lower than on an unsecured credit line, such as a credit card. Why is this?
It is because the home equity loan that you took out is secured by the property. This means if you do not pay, you lose your home. The mortgage company will repossess the home and foreclose, and will resell it to get their money back. In the case of a credit card, the loan is not secured by any physical property, so it is a higher risk for the creditor. Thus the interest rate is higher.
On a home equity loan, you may be able to pay as little as 3.5% interest at current rates, which is a tremendously good deal.
#2 Tax Deductions
Another big reason that people like to use home equity loans for major purchases is that the interest on the mortgage is usually tax deductible. Most homeowners itemize on their taxes and are able to drop their total tax bill. When you take out equity from your home, you are paying more interest, so that will usually be tax deductible. Many people with a mortgage and a home equity loan on a $200,000 home can easily save $1000 or $2000 on their annual tax bill. The federal government has set up the tax code to be friendly to homeowners, so it is wise to take advantage!
#3 Cash Payment All At Once
A home equity loan provides you with one, single lump of cash all at once. This can have some advantages for you depending upon your situation. Some people may need to pay a large expense all at once, such as medical bills or a major car repair all in one payment.
Another advantage of a home equity loan over a home equity line of credit (HELOC) is the latter can be reduced or terminated if you stop paying or if the value of the home drops. Once you have your home equity loan, you have the money and you can do what you like with it.
#4 Home Improvements
Doing home improvements with a home equity loan is one of the most popular things that homeowners do. Whether you want to upgrade the kitchen, bathroom or add an extension, renovating your home with equity can make sense.
Before you pull that money out, you would be wise to conduct careful research to figure out what home improvements are most likely to give you the best return on investment in your area.
You should know something about the homes in your neighborhood as you are considering how much money to spend on your renovation. If your home is worth $150,000, you probably do not want to install a $100,000 custom kitchen as you will not get your money back. It also could price the home out of reach for the average home-buyer, making it hard to unload. Generally, upgrading a kitchen will return you 80% or more when you sell, but you need to be sure that you do not take the renovation too far.
#5 Paying Off Debt
This is an area where you should use caution, but it can make sense for you to pay off credit card debt with a fixed rate home equity loan.
The thinking is that you will pay a much lower interest rate when you use home equity to pay off your debt. A credit card will charge you 15% or more each year. The interest on your home loan might be 4%. And, it’s tax deductible whereas the credit card isn’t.
However, some people use their home equity loan to pay off credit cards, and then they just run them up again. This is not just counterproductive; it’s dangerous for your home. You now have to make a higher mortgage payment, and paying off that debt with your equity could make your mortgage less affordable at some point. Just be sure that you are paying off debt with your home equity loan for the right reasons. Don’t use it as a chance to run up more debt.
#6 Paying for College Education
A college education is often an investment that can pay back dividends for years. So, it can be logical to pull equity out of your home and put it into your or your child’s education.
You should check carefully on how much the education will really cost, and what the potential salary is for that career field. If it is a career that pays well over time, this can be a very good idea. But if you spend $100,000 on an education that will probably never pay you more than $50,000 per year, this type of investment is questionable.
A home equity loan is often a great financial tool for major purchases. You as the homeowner just have to do your homework to be sure that whatever you are spending the money on is a wise investment of your home equity.
After you do your homework and consider the points above, you should be able to decide if a home equity loan is the right solution for you.