Understanding equity

Equity refers to the amount of your home that you actually own. This is determined by subtracting the amount you owe from the value of your home. While a home equity loan may give you the cash you need, it reduces the amount of ownership you have in your home.

Understanding Lenders

You can obtain a home equity loan from almost any financial institution. However, some options may end up costing you more money. Understanding the differences between lenders can help you to find the best home equity loan terms.

Banks and credit unions both offer home equity loans. While these financial institutions may seem to operate the same on the outside, there are a few differences. These differences can often mean savings for you.

Credit unions, unlike banks, are not driven by financial gain. In fact, credit unions are nonprofit institutions. Banks, however, have investors to pay and cater to. This can make all the difference in saving when obtaining a home equity loan. The drawback is that, in order to obtain a home equity loan with a credit union, you must first become a member. To become a member, you must meet a certain criteria. Generally, you must belong to a specific church, live in a specific community, or have children in a specific school district.

You can also use a mortgage broker to obtain your home equity loan. Unlike banks and credit unions, brokers do not actually issue the loan. Instead, they help you find a loan. Most brokers work with specific set of lenders.

While it may seem like a broker is your best option for saving money, this isn’t entirely true. First, brokers are not obligated to help you find the best rate. In fact, many brokers often make a commission based on the loan terms that they provide to you. The only way to get around this loop hole is by contracting with a specific broker.

Brokers also have fees that you are responsible for paying. These fees can include points as well as a portion of the origination fees. Points will affect the interest rate of your loan. When working with a mortgage broker, request that they translate their points into a dollar amount for you. This will help you to understand the impact it will have on your loan. You may also be able to negotiate these fees.

Best Rate?

While the best interest rate may sound like the least expensive loan, this is not always true. There are multiple details that go into determining how much you pay over the life of the loan. Points, administrative fees, closing costs, prepayment penalties, and check writing fees are only a few of these factors. When discussing the loan specifics with your lender or broker, it is essential that you get all of the fees in writing. By doing this, you are able to perform an effective comparison when looking at your different loan offers. You also ensure that loan fees are not changed without your knowledge.

Your Loan and Your Credit

Your credit history is one of the elements that your loan rates and payment terms are based on. However, there are many other factors that are considered like you employment status, the value of your home, your outstanding debt, as well as any other financial obligations you may have.

For this reason, you should never assume that your less than perfect credit is ineligible for a home equity loan. Credit requirements often vary from lender to lender. Additionally, if your credit problems are not recent, you may be able to provide the lender with more recent credit references. This, along with any other proof you can provide to the lender could sway their decision in your favor. If, however, they still express a concern in your credit, consider paying off some of your debt and reapplying in six months to a year.

Making Good Use of Your Home Equity Loan

You are not obligated to disclose the reasoning behind your home equity loan or how you spend the money to your lender. However, there are some ways of spending the money that are more prudent than others.

The interest you pay on your home equity loan can be tax deductible. However, there are some uses for your home equity loan that are not only frugal, they double or triple your tax deductions. These options include paying a child’s tuition or making improvements to your home. Adding energy efficiency to your home, including energy efficient appliances can also be a wise and tax deductible choice. Avoid using the money for purposes that will decrease your family’s net worth.

Determining Equity

Your equity is the amount of ownership you hold in your home. To determine this amount, you would subtract the amount that you still owe on the home from the value of the home. While many lenders may offer you a loan that exceeds this amount, moving forward with it would cause you to be upside down in your loan. This means that you would owe more than the home is worth. You should, instead, leave some of your equity untouched. This would leave you equity to borrow against in the future if a financial emergency were to arise.

Types of Loans

There are two types of home equity loans; home equity lines of credit and second mortgages. They each work differently and often have different repayment terms. Understanding these terms can help you determine which loan is right for your financial needs.

A second mortgage would provide you with a lump sum of money. This lump sum would be placed on a repayment schedule, much like your first mortgage, only with slightly higher interest rates. You will also be responsible for fees that are similar to your first mortgage like closing costs and origination fees.

A home equity line of credit allows you to tap in to your home’s equity, a little at a time. You often have a term that you can borrow against your home’s equity, usually ten years. Once the term is up, you may be required to pay your balance in full. However, you may be able to find a lender that will allow you a repayment term for the amount you have borrowed. Just be aware that the longer you have the loan out, the more interest you will pay.

The Importance of Comparison Shopping

Comparison shopping is essential to getting the best loan terms. It will also safeguard you from unethical or dishonest practices that some lenders may try to use. You should always get loan information in a written agreement called a Good Faith estimate. This will protect you from rising interest rates. It will also give you material to compare when looking at the different terms that each lender has to offer.

Where to Find a Home Equity Loan

You can obtain a home equity loan at almost any financial institution. This includes brokers, credit unions, banks, and online mortgage brokers. Some lenders, like credit unions, will require you to qualify for services at their branch before you can be considered for a loan. However, all lenders should require you to qualify for the loan itself.

Avoiding Dishonest Lenders

While most lenders are honest and upfront, there are always a few bad eggs in the bunch. These lenders are often pushy and try to pressure you into a loan that you don’t feel comfortable with. They avoid answering questions about rates and terms. They fail to address your needs. They may even falsify documents. They almost always fail to give you a Good Faith estimate. Avoid these lenders and cut all ties.

What to Use the Money for

What you use the money on is, ultimately, your decision. However, it is important to keep in mind that you are borrowing against the ownership of your home. By using the money wisely, you can increase your family’s net worth and better your financial situation. However, misusing this money can create a higher debt for your family.

Some of the best uses for home equity loans include the purchase of another home, paying for college tuition, repairs around your home, energy efficient appliances, and retirement funds. Some of the worst ways to use the money include debt consolidation, vacations, vehicles, and luxury expenses. These uses deplete your family’s net worth and increase your overall debt.

Things to Look Out for

While not all of these practices are illegal or deceptive, per say, many of them are terms that you may not be looking for. This can cost you thousands over the course of your loan. Balloon interest, prepayment penalties, check writing fees, hefty late fees, and account maintenance fees are the most common deal breakers. These should be avoided, if at all possible.

If You Are Denied

If you are denied for a home equity loan, consider other options that can help you obtain the finances you need. Because credit is a big determining factor in your home equity loan application, you may consider spending some time working on your credit history. However, you can also be denied for having a high debt-to-income ratio. Try clearing up your credit or reducing your amount of debt. Your lender should disclose the reason for your denial.

What is Equity?

Equity is the amount of difference between the total value of your home and the amount of money you still owe. Generally, home equity loan lenders will only use 75% of your home’s value when configuring the amount of money to lend. This is to protect the lender from any depreciation in your home’s value.

A home equity loan works similar to a mortgage. An interest rate is applied to the amount you owe and there are set repayment terms on the loan. When choosing your home equity loan, you have two different options to choose from; a second mortgage or a home equity line of credit.

Second Mortgage

Of the two types of loans, a second mortgage most resembles your original mortgage. Like your first mortgage, there are fees included in the process. These fees can include, but are not limited to, closing costs, administration fees, lender fees, pre-payment penalties, appraisal fees, and origination fees. However, there is a notable difference between your first mortgage and your second mortgage. Second mortgage rates tend to be higher than first mortgage rates.

In a second mortgage, your lender will allow you to draw a large sum of cash against the equity of your home. This amount is paid back over a specific period of time. Because this type of loan allows you to draw a large amount, you do run the risk of taking out too much money. If this happens, you end up paying interest on money that you didn’t need.

Generally, families and individuals use home equity loans for large financial obligations or purchases. Some of the most popular uses for second mortgages include student tuitions, home repairs, purchasing a vehicle, or debt consolidation. There are no specific guidelines on how you use the money from your second mortgage. However, some options are more prudent than others.

If you are planning to use your second mortgage to consolidate debt, there are some things you should consider carefully before moving forward. First, you should be certain that there are no other options for consolidating your debt, like debt counseling. While debt consolidation is a good thing, you must remember that you are placing your home up for collateral to pay off this debt. Second, you should also be aware that, if decide to proceed with the home equity loan, you should still seek some sort of debt counseling to help you learn how to change your spending habits. Without making changes to your spending habits, you will end up in the same situation, only worse.

Home Equity Line of Credit

A home equity line of credit, or HELOC, works differently than a second mortgage. You are still borrowing money against the equity of your home. However, the money is not given to you in a large lump sum. Instead, your lender will provide you with either a checkbook or a credit card that will allow you to draw against the equity of your home in small increments of money.

Most individuals choose this type of home equity loan because it allows them to have a line of credit for emergencies without having to pay outrageous credit card fees. While this may seem like an advantage over an unsecured loan, there are some notable disadvantages with acquiring a home equity line of credit.

The biggest disadvantage applies to the fact that you are using your home as your credit. This will reduce the amount of equity you posses. You also run the risk of losing your home if a job loss occurs or your financial situation changes. Because a home equity line of credit is a secured credit line, you cannot consolidate or settle this type of credit like you can an unsecured loan.

There may also be stipulations placed on how you draw against your home equity line of credit. There may be minimum amounts that you can withdraw each time and you may be required to carry a minimum outstanding balance. If you fail to follow these guidelines, you may have to pay extra fees. You may also be required to withdraw an initial amount upon acquiring your home equity loan.

Generally, home equity loans allow you a specific amount of time that you can draw money. This time period is generally ten years. At the end of the term, you may be required to pay the outstanding balance in full. However, there are some HELOC loans that will allow you to renew your term or allow you a fixed term for repayment of the outstanding balance at the end of the term.

While a home equity loan may seem like the answer to your financial troubles, there are some important factors to consider. A clear understanding in the terms and how each type of loan works can help you to determine if you are making a wise financial decision.

What is a home equity loan?

A home equity loan allows you to borrow money by placing your home up for collateral. You can borrow up to 75%-80% on the value of your home. By obtaining a home equity loan, you enter a legal contract with a lender stating that you will pay back this amount, plus all interest applied, within specific terms that are set by the lender. Generally, home equity loans carry a 15 year term. While this often makes your home equity loan payments higher than your mortgage payments, you will pay less interest on the home equity loan.

Understanding collateral

Collateral allows you to use an item of substantial value to help you acquire a loan. This item must exceed the amount of the loan. If the loan is not paid for, according to the terms that you and the lender have agreed upon, the lender has the right to take your collateral and sell it.

Your original mortgage payment was a collateral loan. So are car loans. Lenders do not usually loan large amounts of money without some form of collateral. This ensures that they do not lose out on the money they lend to you.

Advantages and disadvantages to home equity loans

Home equity loans do allow you to obtain a loan, particularly when the amount of money you need is great. However, failure to repay the money will result in the loss of your home. You should carefully consider whether or not you have the funds to pay back the loan before committing to the terms.

The money loaned to you on your home equity loan is generally tax deductible. Additionally, home equity loans usually have a lower interest rate than unsecured loans. However, like most situations that involve money, unethical and illegal practices do occur. It is important to safe guard yourself against potential scams.

Home equity loan fees

Finding a lender that does not require you to pay fees on your home equity loan may be possible. However, the chance is rare. If you do find a lender that claims you don’t have to pay any upfront costs, you should check to see if they roll these costs into the loan. Expect to pay fees similar to the fees you paid during your mortgage. Appraisals are almost always required. You are responsible for the cost of the appraisal.

Does your home have to qualify?

All homes must qualify for a home equity loan. These qualifications will relate to the results of the appraisal as well as the type of structure your home is considered to be. Homes that are zoned as residential properties usually qualify, as long as the appraisal results are satisfactory. Mobile homes, however, do not usually qualify for home equity loans. Additionally, unique home structures like log houses may not qualify for a home equity loan.

What can you do with your home equity loan?

There are no stipulations placed on how you can use your home equity loan. You may use it on anything you see fit. The most frugal approach would be to use the funds to repair your home. This will increase the value of your home. However, borrowers use their loans for other purposes like purchasing a vehicle, funding a child’s college tuition, or paying off debt.

Can a home equity loan be refinanced?

Refinancing a home equity loan can sometimes be more difficult than simply refinancing your mortgage. Lenders often frown upon refinancing the large sum of money when you have a mortgage and a home equity loan. However, it is possible to accomplish refinancing, if it is a favorable decision.

While refinancing can save you money in some situations, it is not always the best answer. By refinancing, you are, essentially, restarting the loan. This can cause you to pay more interest over the life of the loan. Carefully consider whether or not refinancing your home equity loan is a good financial decision.

Protected against discrimination

While applying for a home equity loan, you are protected against discrimination under the Fair Housing Act and the Equal Opportunity Credit Act. This means that you cannot be denied a loan based upon your age, marital status, sex, race, color, national origin, religion, or familial status. There are, however, other reasons like credit, insufficient value in your home, or failure to provide ability to repay that can affect your ability to acquire a home equity loan.

While a home equity loan may not be right for everyone, it has provided many families and individuals a means to manage a serious financial burden. Understanding how they work can help you decide if it is a financial decision that is right for you and your family.

Home Equity Loans Explained

Home equity loans allow you to apply for and obtain a loan by offering your home up as collateral. These types of loans can provide you with a large sum of cash. However, because your home is used as collateral, you do place yourself at risk for losing your home if you do not meet the terms of the agreement. Before considering a home loan, you may want to be sure that you have no other viable options.

Before You Start Searching

Before you can start searching for a home equity loan, there are a few things that you will need to do to prepare yourself. First, you should take the time to familiarize yourself with the different loan types as well as their pros and cons. Try to understand the basic meaning of common loan terminology so that you are adequately prepared to know which fees are reasonable.

You will also want to spend a fair amount of time considering the home equity loan itself. Consider what you need the loan for so that you can adequately determine just how much you need to borrow. Once you know how much you plan to borrow, start outlining different aspects of the loan, including how much you can afford to pay monthly, how long you want the repayment period to be, and what type of interest rate you are looking for. You can use a mortgage calculator to help you determine which repayment options will best fit your monthly budget.

Once you are clear on your terms, know which terms you are willing to be flexible with. Which terms will you stand firm on? This will leave you room for compromise while still allowing to keep your financial plan as close to the original as possible. Always remember, no matter what a lender tells you, you are the best person to determine what you can handle in term of your finances. Do not allow them to pressure you in to loan terms that make you uncomfortable.

The Importance of Comparison Shopping

As with most financial decisions, whether it is buying a pair of shoes or finding a home equity loan, shopping around can save you money. While a pair of shoes might only save you a few dollars, shopping around for the right home equity loan could, potentially, save you thousands.

While shopping around for your home equity loan, speak with different types of lending agencies, including lending brokers, credit unions, and banks. The more lenders you talk to, the better chance you have at obtaining the best loan terms.

Because your loan is based partly on your credit, you will want to be sure that you avoid multiple inquiries on your credit. This will decrease your credit rating. Ask lenders to wait to officially pull your credit until the loan process actually starts. You may even consider obtaining one credit report on your own accord and taking it with you to each lender. While they will need to pull a report on their own once the process starts, this can give them a good idea of what your credit looks like ahead of time. This will ensure that they are able to offer you a more reliable rate, based on your credit rating.

Working With Brokers

You will not always know immediately that you are working with a broker. Some lending agencies use brokers within their business that go by different titles. You should always ask if someone you are working with a broker. This information can change the rates and specifics of your loan.

While a broker may be able to help you find a better rate, brokers often have additional fees that you are responsible for. The most common fees associated with brokers are called points. Points are tied directly in with your interest rates. You may be able to negotiate these points. You must, however be aware of their presence to negotiate.

Negotiating With Your Lender

Don’t be afraid to make lenders compete for your business. Take your best rates and schedule fees with you to each lender appointment. See if a lender can beat your prime deal. This negotiation process can shave thousands off of your loan fees.

You should always ask a lender to write down schedule that details all of their fees as well as the amount. Having this information in writing will ensure that, while you are negotiating specific fees, that the lender doesn’t increase the price of one fee while reducing the other. Doing so locks you in to the rate they have quoted, protecting you from interest rates, if they should happen to rise before the loan is closed.

Watch Out For Deal Breakers

Deal breakers are considered loan terms that are highly unfavorable. These can cost you thousands of extra dollars. Some of the most common deal breakers include balloon fees, large pre-payment penalties, account maintenance fees, and check writing fees. If you experience a lender that applies any of these fees, avoid them at all costs.

Weighing your decision

Your home is more than just a building with walls and windows. It is an investment. By taking out a home equity loan, you are giving up part of your ownership in your home to fund your financial need. Whether or not you realize it, taking out a home equity loan will be one of the biggest financial decisions you will ever make, next to your initial home loan.

Why is finding the right terms so important?

Your home is being placed up for collateral for the funds you plan to borrow. Failure to meet repayment terms can, ultimately, result in the loss of your home. This is commonly known as foreclosure. Finding terms that fit your budget and your needs can help you to better plan for the payments and help protect you against foreclosure.

Broker, bank, or credit union?

There are a number of places that you can go to obtain your home equity loan, each with advantages and disadvantages. Brokers, while they charge a fee that is reflected in your interest, do work with a number of lenders. Although they are not required to find you the best rate, they can sometimes offer you more favorable terms because of their number of resources.

Banks do not charge you broker fees, as long as the bank does not use a broker for home equity loans. Be sure to ask this question when speaking with the loan officer. Credit unions tend to offer highly favorable terms because they are not motivated by financial gain. However, you have to be able to join the credit union in order to obtain a loan through them.

When it comes down to it, you should go for the lender that offers you the most favorable rates. To determine which lender has the best rates, you will have to do comparison shopping.

Always comparison shop

Never, for any reason, take the first loan that is offered to you. Always shop around. Visit different lenders with different institutions. Visit different types of lenders. Not only will this help you find the best rate, it will also protect you from potentially dishonest lenders.

You should always get a Good Faith Estimate. This prevents you from being subject to increased fees. It also provides you with concrete material when comparing loan terms. Never be afraid to take in a Good Faith estimate to another lender to see if they can beat it. Make your lender work for your business.

Spotting dishonest lenders

You may not encounter a lender that uses illegal practices. However, you are likely to encounter at least one that is dishonest. Learn how to spot them quickly and avoid them completely.

The best way to spot a dishonest lender is by obtaining a large number of loan quotes. This will familiarize you with which fees are normal. You will also become aware of a normal range for these fees. If a lender charges you several times the amount on certain fees than all of your other lenders, they are most likely inflating those fees to receive a personal profit.

Dishonest lenders can also be extremely pushy and may try to pressure you in to a loan that you don’t feel comfortable with. Never make a decision on the spot. Request all information, in writing, and take it home to compare with your other quotes. If a lender refuses to give you rates and fees in writing, cut all contact with them.

Look for a lender that makes you feel comfortable

Don’t mistake a lender that makes you feel comfortable with a lender that charms you. Charm and deception can often go hand in hand. Recognizing the difference can help you avoid a deceptive lender.

A deceptive lender will often reflect questions and change the subject. A lender that makes you comfortable will make sure that your questions are answered. If they do not know the answer to your question, they will find out from someone who does. A lender that is trying to charm you will avoid talking about certain fees. A lender that makes you feel comfortable will clearly outline all fees for you. They will speak with you openly about all of the fees and the terms of the loan. A lender that is trying to charm you will not address your needs. They may often ignore your needs altogether. A lender that makes you feel comfortable will address your needs and try to meet them to the best of their abilities. A deceptive lender will make changes to your financial documents to try to qualify you for a loan. A lawyer that makes you comfortable will talk with you about your income and credit and to their best to obtain the loan. However, they will not guarantee an approval.

What is the purpose of the loan?

Although you are not required to account for the reason of your loan to your lender, it should be one of the factors that you consider before deciding to take out a home equity loan. While some reasons for taking out a home equity loan can provide you with a financial decision that is favorable, others could create serious setbacks.

Taking out a home equity loan to pay for any financial obligation that would depreciate your family’s net worth is usually a poor financial decision. This can include the purchase of a car, payment of credit card debt, or luxury expenses like a vacation. If you need to purchase a vehicle or you want to pay for a luxury expense, find other means of funding it, like saving. If you want to pay off credit card debt, consider seeking credit counseling first.

Do you have other options available?

Some uses for home equity loans may not lessen your family’s net worth. However, there may be other options for funding the expense. College tuition may be covered by government grants or loans. You may be able to adjust your budget to achieve funds necessary for home repairs. Consider all of your options before entering into a home equity loan.

Consider the economy

A drop in the economy will often result in a lower face value of your home. This can occur either before, during, or after you obtain a home equity loan. This drop can result in you owing more than the home is actually worth. While the economy may recover, it could prevent you from being able to sell your home.

Do you have the resources to pay back the amount you owe?

Because you are placing your home up for collateral, failure to repay the loan, according to the terms, can result in the loss of your home. You may not be able to plan for all financial situations like a serious injury or a job loss so it is important that you have a back-up plan in case something should happen.

How much equity do you have?

Many lenders will offer you a loan amount that is more than the equity that you own. The extra cash is often tempting. Following through with this, however, places you upside down in your loan, meaning that you owe more than it is worth. Additionally, if you use all of the equity in your home, you no longer have any ownership or safety net if a financial emergency arises down the road. Because it takes a great deal of time for equity to build in your home, you may want to consider leaving a fair share of equity untouched. This will provide you with equity in the event that a financial emergency should occur.

Do you need the money now?

If you do not have an immediate need for funds, consider taking out a home equity line of credit. This will allow you to tap in to your home’s equity when it is needed. However, it is important that you manage this wisely. Excessive use could create payments that are more than you can afford and you can quickly use up your equity if you are not careful.

What is your credit status?

Because your interest rates are partially weighted on your credit, taking out a home equity loan right after credit problems will likely result in higher interest rates. Consider caring for your credit and paying off some bills before moving forward with your home equity loan.

How long do you plan to live in your home?

If you are planning on selling your home anytime in the near future, you may want to consider other options for your financial needs. Many lenders will charge you expensive prepayment penalties. If you have used a large amount of your equity, you may not have much left. This could result in a total loss when you do sell.

How much do you owe on your first mortgage?

Owing less on your first mortgage or having your home completely paid off can give you a serious advantage when applying for a home equity loan. This is because you have acquired a large amount of equity. You will still owe a large portion of your home, as long as you don’t borrow more than you need.

How much money do you really need?

You may decide that a home equity loan is your only option. In this instance, it is vital that you carefully consider how much money you really need. This can help you avoid paying interest on money that you did not need.

Failing to carefully go over terms

Reading financial paperwork may not be fun, but it is essential. Not reading the paperwork carefully can leave you unprotected against unethical practices. It can also cost you thousands of dollars.

Watch for introductory rates. While the rate is low initially, after the introductory period is over, this rate can increase substantially. Businesses use these introductory rates to entice home owners. Watch for what is called a “life cap” in your loan paperwork. This amount will indicate how much your loan can increase over the entire life of the loan.

If there is every any information that you do not understand in your loan paperwork, ask the lender to clarify. If you do not feel satisfied with the answer or it is not made clear to you, consider another lender. You may also consider having a financial advisor go over the loan paperwork with you. Even if you have to pay for this service, it could save you thousands, making the cost of a financial advisor well worth the cost.

Not taking care of your credit

Your credit is one of the determining factors in your home equity loan. By failing to care for your credit, you leave yourself open to experiencing higher interest rates. Poor credit management could also indicate that you should reconsider your decision to obtain a home equity loan.

Not being aware of the differences in home equity loans

Home equity loans come in two types; home equity lines of credit and second mortgages. Failing to recognize the difference can result in poor management of funds. It could also rob you of an opportunity to utilize a more favorable loan for your situation.

Home equity lines of credit allow you to tap in to your home equity in small increments, making this option rather favorable for small financial emergencies or obligations. Second mortgages are given to you in a large lump sum. These are often used for large financial purposes.

Borrowing too much money

Borrowing too much money is a risk with both types of home equity loans. However, second mortgages have a much higher risk because of the large amount you are allowed to borrow. You are charged interest on what you borrow, not what you use. Borrowing more than you need creates interest payments that were unnecessary.

Not refinancing before you obtain a home equity loan

When refinancing, lenders will look at the total amount you owe on the home. If the combined loans exceed the value of the home, you will, most likely, have a difficult time refinancing your mortgage. If you plan to refinance, do so before obtaining the home equity loan.

Failing to comparison shop

By only shopping with your current lender or personal financial institution, you are greatly limiting your options. Lower rates and more favorable terms may be available through other lenders. To obtain the best terms, obtain rates from multiple lenders and brokers. Then, take the time to analyze each loan carefully, selecting the one with the most favorable terms.

Not asking for a Good Faith estimate

When you are quoted a loan term, you should always ask for a Good Faith estimate. These are designed to protect you from interest rate increases and fees that the lender may change at the last minute. This could result in a loss of thousands of dollars.

Paying only interest

Most home equity loans will allow you to pay only interest in the beginning of the loan. While this may seem convenient, it is also poor financial planning. The sooner you start applying funds to the principal, the sooner you can have the loan paid off. By paying the loan off, even months early, you save money on interest fees.

Overlooking prepayment penalties

Some lenders shell out hefty prepayment penalties. Failing to notice these could result in a lot of lost money, especially if you plan to sell your home in the near future. If you do not see prepayment penalties in the loan agreement, be sure to ask if there are any.

Using home equity loans to pay off credit card debt

It may seem like a good idea to pay off high interest credit cards with your home equity loan. Paying high interest credit cards with your home equity can save you money on interest, if you manage your debt effectively and make changes in your spending habit. However, by paying off your credit card debt, you may be tempted to spend more, resulting in even more debt than you started with.

Not using your home equity loan tax deductions

Your home equity loan interest payments are tax deductible up to the first $100,000 borrowed for most purposes. If you use your home equity loan to buy another home or make repairs on your current home, you can deduct up to the first $1 million owed. Tax deductions can save you money.

Understanding the basics of home equity loans

In a home equity loan, you borrow against the equity, or the percentage of your home, that you own. While the cash may be helpful, it is essential that you understand that, by taking out a home equity loan, you decrease the amount of your equity.

The equity of your home is determined by subtracting the amount you owe from the value of your home. Most home equity lenders will not loan based on 100% of your home’s value. Instead, it is based upon 75%-80% of your home’s total value. This is done to protect lenders from economic changes that can depreciate the value of your home.

Like all types of credit, there is interest that must be paid on your home equity loan. The type of interest you must pay is determined by the lender that you choose and the options that they have available. The amount of your interest is determined by your credit and where you obtain your loan from.

Home equity loans are available in two types; second mortgage and home equity line of credit. A second mortgage will provide you with a lump sum while a home equity line of credit will allow you to tap into your home’s equity in small increments. Some home equity lines of credit have minimum amounts that you should be aware of.

Evaluating the reason for your loan

The single, most effective way of determining whether a home equity loan is right for you is to consider the reason that you want the loan in the first place. By considering your reasoning, you can determine if you have other options that are more favorable. Considering the reason can also force you to take a look at your credit and debt status.

Student loans or tuition

Using a home equity loan for a student loan or tuition can often be more cost effective than applying for a student loan. Because your home equity loan is secured, you are often able to obtain more favorable interest rates. However, if you or your child is able to qualify for grants or government loans, you may want to exhaust these options first. Grants are government money that does not have to be paid back. Government loans often have grace periods that allow you to defer payment until six months after graduation. They also have much lower rates than other types of loans.

Using a home equity loan for educational purposes can also double your tax deductions. Your home equity loan is tax deductible on the interest you pay up to the first $100,000. Student loans are also tax deductible.

Home repairs or renovations

Home repairs and renovations are another common use for home equity loans. Some home repairs are necessary to avoid future problems of the home, like roofs and plumbing. Others create energy efficiency like windows and insulation. Still other home repairs simply increase the home’s value, like adding a pool or patio.

Using a home equity loan to perform repairs on your home is almost always a good financial decision. Exceptions include not being able to handle the repayment of the loan or if you are planning to sell your home within the next couple of years. If you cannot handle the payments, you could lose your home, making the repairs in vain. If you plan on selling your home within the next couple of years, you could face hefty prepayment penalties for paying off the home equity loan early.

Debt consolidation

If you plan to use your home equity loan for debt consolidation, it is essential that you take a serious look at your credit and your debt situation. While a home equity loan may seem like an effective means of consolidating your debt, it also puts you in a situation that you are more likely to incur more debt. This can create a viscous cycle, leaving your family’s net worth depreciated and place you in a desperate situation.

For some cases, debt consolidation may be reasonable. Maybe you were in an accident and incurred a number of hospital bills and lost time off of work. If these bills were placed on a credit card, you could experience substantially higher fees than you would by paying these bills with your home equity. Again, it is important to consider why you need debt consolidation and how you can prevent the problem from occurring again.

Home equity loans can often be a good financial choice. However, not taking the time to consider your financial situation could leave your family in financial turmoil. By carefully considering your purpose for the money, you can prevent this from happening.

What is a home equity loan?

A home equity loan is a secured loan in which you put your home up for collateral. Home equity loans work similar to mortgages. Interest, monthly payments, and interest are all aspects in a home equity loan. Upon loan approval, you agree to the terms outlined by the lender regarding repayment.

Home equity loan advantages

A home equity loan allows you to unlock the cash value of your home without selling it. There are no stipulations on what you can spend the money on. Borrowers do not have to disclose the reason for the loan to the lender. Common uses for home equity loans include home repairs, debt consolidation, student tuition, and purchase of a vehicle.

Home equity loans tend to be extremely appealing to individuals with less than perfect credit. This is often due to the fact that home equity loans are easier to qualify for. Home equity loans are easier to qualify for because the home is used as collateral. This creates less risk for a lender than an unsecured loan.

Because of the lower risk, home equity loans often have lower interest rates than unsecured loans. Lower interest rates mean less money to pay back over the term of the loan, saving you money. For this reason, some borrowers choose to pay off unsecured loans with their home equity loans.

Using your home equity loan to pay off debt can simplify your financial planning. No longer do you have to worry about multiple payment due dates. Instead, you have one monthly payment to your home equity lender. When creating your home equity loan, you can also set the repayment date on the loan, allowing you to effectively plan your monthly payments.

Interest paid on home equity loans are also tax deductible. The amount you can deduct on your taxes will depend on how you use the money borrowed. For general purposes like student tuition, purchase of a vehicle, or debt consolidation, you can claim deductions on the interest you pay on the first $100,000 borrowed. However, if you use the money to make repairs on your home or purchase a second home, you can deduct the interest you pay up to the first $1 million borrowed.

Certain uses for home equity loans may also provide you with additional tax deductions. Certain home repairs can create additional tax deductions. This will also increase the value of your home, increasing your family’s net worth. However, not all repairs qualify. Most home repairs that qualify for tax deductions must increase the energy efficiency of your home. Paying for a student loan or tuition can also create an additional tax credit.

Disadvantages to home equity loans

While there are a number of advantages to home equity loans, there are also a large number of disadvantages. Before making your decision, you should take the disadvantages into account as well.

The biggest disadvantage is that your home is used as collateral. If you fail to repay the loan according to the terms and guidelines, the lender can take your home and sell it. This can be an extreme risk if you are facing a job change or job loss.

Even if you do not default in your payments enough to have your home taken, creating a poor payment history can create other issues. The lender may choose to place a freeze on your credit, disabling you from being able to apply for additional credit. They can also request that you repay the loan in full.

You must also qualify for a home equity loan. While it may be easier than applying for an unsecured loan, there are requirements, including a proper assessment of the value of your home. Additionally, some types of homes, like mobile homes, may not be eligible for a home equity loan.

By taking out a home equity loan, you also reduce your ownership in the home. This reduced equity can create a number of problems. If you plan to sell your home, you may end up losing a substantial amount of money. You can also end up owing more money than your home is worth if the economy in your area decreases while paying back the loan.

While the interest rates on home equity loans are often lower than the interest rates on unsecured loans, the interest is often higher than the rates on your initial mortgage. Because you must pay interest on the loan, borrowing too much money could result in a serious loss of money.

While some uses of a home equity loan may seem like a good idea, some could result in a loss of your family’s net worth. The wisest choices for home equity loans are educational expenses, home repairs, and debt consolidation.