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Here's how it works. Let's imagine that your home mortgage is for $250,000, but after years of paying on that note, you only owe the mortgage company $100,000. In this instance, you would have $150,000 in equity in your home. A home equity loan is a specific type of loan that will allow you to borrow against that equity.
Why would you want to do this? The number one reason that people take out home equity loans is as a means to consolidate their debt. Because a home equity loan is a secured loan, the interest rates are considerably lower than that of credit credits or personal loans. And so if a person had $10,000 in credit card debt, they could reduce the total amount of owed—as well as their monthly payments—by taking out a home equity loan and using the cash to pay off their credit card debt.
Another great reason for taking out a home equity loan is to make improvements on your home. Have you been thinking about adding a swimming pool to your backyard? A greenhouse to your yard? A new bedroom or bathroom addition? A home equity loan is a great way to finance those types of projects.
Your first step should be to talk to your current mortgage company about your options, but don't stop there. You will quickly find that there are plenty of companies who are willing to lend you money against your house, and so you should shop around for the best deal.
And that brings us to our final point. A home equity loan is secured by your home. What that means is that if you don't make the payments on time, the lender will have the right to take your home and sell it in order to collect on the debt. Make sure that you are in a position to pay back any amount you borrow against your home!
This loan is set for a fixed amount of time, anywhere from five to fifteen years. Such loans are typically granted for up to 80% of the value of the home, but some lenders will lend up to 125% of the home's value.Is this type of loan right for you?
The term loan works best for those who need to borrow a fixed amount of money for a specific purpose – paying for a wedding, a home remodeling project, a fixed educational expense, or debt consolidation. This would give the borrower a fixed repayment schedule, where he or she would pay a set amount of money each month for a specific period of time. An increasingly popular alternative to the home equity loan is a line of credit.
This type of loan works like a credit card, and has a revolving line of credit, in which the borrower may borrow against the principal more than once over the life of the loan. The borrower is usually given special checks that he or she may use to write checks against the loan amount. The borrower may borrow a little at a time, or borrow all of the loan amount at once. Unlike the term loan, the interest rate on lines of credit tends to be variable.
This type of loan works best for recurring expenses – a complicated remodeling project accomplished in several stages, or a recurring educational expense such as annual tuition. Each type of loan has its advantages and disadvantages; you simply need to decide if you want a fixed interest rate and fixed payments, or more flexibility in terms of when and how you pay.
Your needs will determine which type of loan is best for you. Either way, under current Federal law, the interest on a second mortgage is deductible from your income taxes up to $100,000.