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Understanding the Second Mortgage: Home Equity Loans

If you’re a homeowner with equity in your residence, you may be in for some good news. Low rates and tax advantages have made home equity loans an excellent source of funds for practically any reason.

What is home equity?
Your home equity is your home’s market value (what you can sell it for) minus what you still owe on it. Perhaps you don’t realize what a large financial reserve this can be. One good thing about inflation – it usually increases the value of your home. For example, say you bought your home 10 years ago for $100,000; its value today may exceed $150,000, increasing your home’s equity by $50,000. If your first mortgage has a $70,000 balance, the total equity in your home is $80,000.

What is a home equity loan?
A home equity loan allows you to take advantage of the increased value of your home, without having to sell it. Why would you want access to these funds? There are three primary reasons:

  • Tax advantages – Most homeowners can deduct interest paid on a home equity loan. This can result in considerable savings over the long run. Consult your tax advisor to see if you would qualify for such deductions.
  • Low rates – Since your home is being used as collateral, the loan is considered to have less risk to the lender. This means that the interest rates charged on home equity loans are usually quite low.
  • Flexibility – The money you borrow does not necessarily have to be used for the house itself. On the contrary – Equity funds can be used for virtually any reason – to purchase a car, pay tuition expenses, finance a vacation, to purchase investments, or for any other reason you can imagine.

How much can I borrow?
Ask your credit union how much of the home’s value you can borrow against. Often lenders have different percentages that they will loan up to. For example, lets say the lender will provide home equity funds for up to 90% of the home’s value. Now lets assume that your home’s market value is $100,000 and you owe $60,000 on your first mortgage. 90% of $100,000 is $90,000, minus the $60,000 you owe, leaves you with a $30,000 maximum loan. As stated, some lenders will allow you to borrow higher or lower than 90%, so it’s a good idea to ask.

Popular Home Equity Products
There are three primary forms of home equity loans on the market.

  • Home Equity Loan – This product carries a fixed rate loan for a fixed term. With this loan, you borrow a lump sum and pay it back in equal installments.
  • Home Equity Line of Credit – As a line-of-credit, this product allows for a bit more flexibility. Once the credit line is established, you can advance yourself funds as you need them. That means you can borrow more money in the future without having to re-apply. Since Home Equity Credit Lines are open-ended, they usually carry a variable interest rate. Check with your lender.
  • Home Equity Credit Cards – A relatively new concept, this combines the tax advantages of a home equity loan with the convenience and worldwide acceptance of a credit card.
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