Home equity loans loan interest rates
Home equity loans have become increasingly common starting from mid-1980. It was the time when property values appreciated considerably. Home equity loans, with their attendant benefits of attractive interest rates and tax deductibility, provided a great avenue to people who knew how to manage their personal debt.
Their popularity surged in 1996. That year, deductions for the interest on most consumer purchases were withdrawn, and home equity loan provided an opening to people looking to at least partially circumvent these tax changes. With a home equity loan, homeowners could still borrow money, and deduct interest paid when filing their tax returns.
Home equity loan and related terms defined.
home equity loan allows a homeowner to borrow money using his or her homes equity as collateral.
First question What is collateral
Any property that you pledge as a guarantee to repay the lender the loan it has given you, is collateral. If you somehow failed to pay the debt, lender will simply take the collateral, which happens to be your home in this case, sell it and will get its money back from the sale proceeds. Thus, when you are taking a home equity loan, you are pledging your most valuable asset as collateral. This is a major decision and we will shortly discuss all its ramifications in detail, because you certainly will not want to face the embarrassment of being thrown out of your own home.
Another term to be understood clearly here is equity. When we talk of home equity, we refer to the difference between how much your home is worth and how much you owe on mortgage.
Lets take an example. You buy a house for $300,000. You make a down payment of $50,000 and borrow $250,000. So, on the day of buying the house, your equity will be: houses purchase price amount owed = $50,000.
Four years later, by making monthly payments, you have paid down $25,000, so now you owe $225,000. On the other hand, thanks to an appreciation in property prices, your home is now worth $350,000. That means, today your home equity is: houses current appraised value amount owed = $125,000.
Home equity loan is also called a second mortgage because it is secured by your property just like your original mortgage, and it allows you to turn your equity into cash. You can spend this case as you feel like.
Home equity loans are repaid in a much shorter period as compared to first mortgages. It is common for first mortgages to be repaid over 30 years, while home equity loans usually have a repayment period between 5 to 15 years.
Types of home equity loans.
There are two types of home equity loans fixed rate loans and lines of credit. A fixed rate loan gives you a one time lump sum, which you pay off over a fixed time period, with a fixed interest rate applicable throughout the life of the loan and same monthly payments. Once you get your loan money, you cannot borrow any further from your loan.
On the other hand, a home equity line of credit is a variable rate loan and works in many ways like a credit card. In some instances, you actually get a credit card with the loan. In this arrangement, borrowers are per-approved for a certain spending limit. So when they need money, they can withdraw via a credit card or a special check. This means you can borrow a certain amount during the loans lifetime, withdrawing money as and when necessary. To illustrate, lets say you have a $20,000 line of credit. You borrow $5,000 from it. At this point, you owe $5,000 and also have $15,000 remaining in the credit line, so you can still borrow another $15,000. Now you pay back $2,000, thus at this point, you owe $3,000 and have $17,000 in your credit line.
The interest rate is variable in this loan arrangement and keeps fluctuating during the life of the loan. Thus, your payment will depend on the amount owed as well as current interest rate applied. However, both in fixed rate loan and line of credit, you will have to pay off the balance loan amount if you decide to sell the house.
As already mention, the reasons for increased popularity of home equity loans are not very difficult to comprehend. First, they have a lower interest rate as compared to credit cards or auto loans. Next reason is that today, interest on almost all consumer debt is non tax-deductible, except mortgage debt. Interest on mortgage debt is still tax-deductible.
Same is the case with home equity loans up to $100,000. So, it a way of saving your taxes also. However, we must carefully ponder over the question -- are these benefits strong enough to justify putting your home on the line Those arguing in favor will say that equity loans up to $100,000 saves your taxes, their interest rate is lower than credit cards or other unsecured personal loans and there is nothing wrong in making your home equity work for you. After all, you can use this cash judiciously to do so many things consolidate your previous debt, carry out home improvement and up gradation which increases your homes value, pay your childs college tuition fee, meet unexpected medical costs and other such emergencies, or purchase few big ticket items.
But the most important point is that if, for any reason whatsoever, you defaulted on loan repayment, the lender will be all too happy to sell off your home and thus you will lose your biggest asset which you may have acquired after years of efforts. And trust me; most lenders view home equity loans as a dream come true. After all, a lender earns interest and fees on your original mortgage, and then earns even more interest and more fees from the same property, this time by a home equity loan. Then, due to any reason, if a borrower defaults, the lender will not only keep all the money it earned from the original mortgage as well as the home equity loan (second mortgage), but will also repossess the property, sell it and will start this same process all over again, with the new borrower. Tell me, can you really think of a more attractive business-model from a lenders perspective. Thus, recognize that home equity loans can work in favor of only responsible buyers. Only if you have a steady and reliable source of income and you are confident that you will be able to repay the loan without difficulty, go for a home equity loan. Dont make the very costly mistake of treating home equity loan as a God send opportunity to get out of your perpetual cycle of spending, borrowing, spending, borrowing and all the time sinking deeper into the debt trap. By taking a home equity loan just to pay off their previous debt, such irresponsible borrowers find themselves, sooner rather than later, facing the harsh reality of being thrown out of their own home by the lender.
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