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June 27, 2018
Your home may hold the key to achieving many of your financial goals. Ilyce Glink, a syndicated real estate columnist and author of 100 Questions Every First-Time Home Buyer Should Ask, reports that the younger you are when you buy a home, the wealthier you will be in your lifetime. It's true that the greatest component of personal wealth in America is home equity.
Special loans let you convert the equity in your home into cash to pay for things like a car, your child's college education and home improvements. Some borrowers use the loan to consolidate debt or take advantage of an investment opportunity. Before you join the ranks of home equity enthusiasts, make sure you understand the basics of borrowing "on the house."
Home Equity Loans Come in Two Forms
There are two types of home equity loans: term, or closed-end (also known as a second mortgage), and line of credit. Closed-end loans provide borrowers a lump sum of money at a fixed interest rate to be repaid in equal monthly installments over a specified loan term (typically 10 to 15 years).
A home equity line of credit (HELOC), on the other hand, charges a variable interest rate and functions like a big credit card. You have a minimum payment due each month based on how much of the credit line you've used. You can draw on your line of credit whenever you want to, using checks provided by the lender. At the end of the term, which could be anywhere from five to 20 years, you must pay off the full balance. At that time the lender will choose whether or not to renew the loan.
Rates on home equity loans and lines of credit are influenced by many factors, but generally tend to be lower than rates on non-mortgage loans.
The big attraction to home equity loans is the fact that, for many borrowers, the interest charged is tax deductible (just the way it is on your first mortgage). This can result in huge savings, and is the reason so many homeowners use a home equity loan to consolidate non-deductible, higher-interest debt like credit cards and auto loans.
While tax deductibility is a huge reward, there is a risk that comes with home equity loans as well. Because the collateral for a home equity loan is -- you guessed it -- your home, there is some danger of losing it.
Doreen Woo Ho, former president of the home equity division of a national lender, cautions that homeowners who choose to borrow against the equity in their home must be fiscally responsible. "Anytime a home is used as collateral, a homeowner runs the risk of losing it if they fail to make the loan payments," says Woo Ho.
Because you're putting your home on the line when you take out a home equity loan, borrowers may want to steer clear of "no-equity" loans, which lends more than 100 percent of the value of the property. Borrowing more than your home is worth might sound like a good deal now, but finding yourself unable to make payments on a sum of money that exceeds what you could sell the home for if you had to is no picnic. And because these hybrid loans combine a home equity loan and an unsecured personal loan, they may charge a higher interest rate and not qualify for full tax deductibility.
How to Qualify
The most important qualification is that you have equity in your home (usually because you made a large down payment, have made improvements or additions, or have owned the property for a number of years). You typically need at least 20 percent equity to get the lending institution's lowest rates.
The lender will also consider your credit score, income, and debt-to-income ratio. However, the underwriting requirements tend to be much less stringent for a home equity loan than they are for a first mortgage.
You can apply for a home equity loan with the same lender who carries your first mortgage, but it isn't necessary. Most credit unions and banks offer home equity loans, and there are many Web-based brokers that will help shop your loan application out for the best rates.