The equity you have in your home can be a powerful tool in managing your overall financial situation. Your equity, the value of your home minus your existing mortgage, can serve as collateral for additional borrowing.
Attractions of Home Equity Loans
Convenience - It easy to apply and the approval processes can be fast. The process is often simpler than if you were applying for a new mortgage. Once you are approved, the commitment acts like a line of credit. You do not have to borrow it all at once.
Interest rates - The interest rates charged on home equity loans are usually greater than those on first mortgages but less than those on credit cards. Often, you are only required to pay the monthly interest with the principal to be paid later.
Tax benefits - For many individuals that itemize their tax deductions, the interest paid on home equity loans can help save some income taxes. There are some limits on this type of interest deduction so consult with your tax advisor for more details.
Flexible uses - Even though you are borrowing against your house, there is no requirement that the money be used on your house. A home equity loan can be the source of funds for paying off credit card balances, college tuition or even to buy a car.
How does a home equity loan work?
You may get a special check or a checkbook to enable you to access funds when you need htem. There are usually forms to sign and an approval process that is not too difficult. There may be some form of commitment fee.
The amount you can borrow depends on the amount of equity in your home and your other credit characteristics. A general rule of thumb is that you may be able to borrow up to an amount so the total debt against your home (including the first mortgage and any other loans where your home is pledged as collateral) is less than 75% or 80% of the current value of your home.
The interest rate charged will usually be variable and will be tied to some published index, like the prime rate. Be sure to check out the rate details. Usually, you repay the loan in regular installments and 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.
Beware of the risks
Borrowing against the equity in your home should be considered carefully. Even though there are benefits, these types of loans are like other loans - you pay interest and they must be paid off. Most people use home equity loans for "conservative" purposes and avoid making risky investments or extravagant spending with the proceeds.
Read and understand all the details before signing. Loan documents can be confusing and the easy process of getting this type of loan can mask the costs and risks.
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