Home Equity Loan Lowdown

Why pay cash when you can finance your home & save taxes

You’ve probably been working hard and saving up for a comfortable, debt-free retirement. However, if want a retirement property, don’t try to pay cash – it’s not always the best option. What you could do instead is finance your home by choosing from a wide variety of options. Businessweek.com reports:

According to bankrate.com, the average interest rate is lowest on the mortgage, next lowest for the HELOC and the home-equity loan. The rate on a home-equity loan is fixed, while a refinancing loan can be either variable or fixed; a HELOC is variable and could turn out to be costly if rates continue to rise.

Read more: Buy The Nest, Keep The Egg

Shady home equity loans could leave you with no money and no home!

It’s not easy being Zoraida Colon. She not only suffered the injustice of having her house torn up without any of the promised repairs being carried out, she also has had to $122 every month for a home-equity loan for the past seven years! Timesleader.com reports:

Builder Brad Marks and partner Edwin Rivera targeted mostly low-income Hispanics through Spanish-language ads that promised affordable loans for home improvement projects, prosecutors said. The pair then pocketed the loans and hired shoddy subcontractors or no one at all to do the work. Marks pleaded guilty to federal fraud charges and testified against Rivera at a trial last year that ended with his conviction

Read more: Victims, duped into shady home-equity loans, discuss loss

Not all debt is bad

Freedom from debt is something that all of us long for. And this freedom extends to our homes. But if experts are to be believed, debt is not bad, or rather not all kinds of debt are bad. They would have us believe that mortgage is not such a bad idea after all! According to them, your home is like a piggy bank. The bank is full with money you've already put in. And you can take out this money with a home equity loan.

There are however certain rules to be followed when you take a loan against your home. Always use the loan amount to buy something that will add value to your home. Don’t try to take the loan for something as frivolous as a vacation or a depreciating asset like a big TV. If you are taking the loan for such a purpose, then remember, it is as good as pouring money down the drain.

It’s not easy having a HELOC

Having a home equity line of credit (HELOC) is not an easy task. The problem with it is that you are forced to answer a couple of uncomfortable questions. Questions that may help you with your finances but are nevertheless, troublesome. One of the first things you are required to ask yourself is if you should keep the credit line, even though the rate has almost doubled in 21 months or refinance it. This, believe me folks, is a pretty tricky and confusing question. If you remember your math, then this is the time to crunch those numbers.

You are probably wondering why make such a fuss about something as basic as a home equity line of credit. Well, until recently, it was something that didn’t require too much fuss. They offered rates that were lower than those on fixed-rate home equity loans or first-lien mortgages.

But this is no longer the scene today. The fact that credit lines are indexed to the prime rate meant that those good times couldn’t continue forever. Every time the Federal Reserve raises short-term rates, borrowers' minimum monthly payments go up. Since 2004, the rates have been raised so many times that now the prime rate has gone up from 4 percent to 7.75 percent.

So now, the average rate on a credit line is higher than the average fixed-rate home equity loan. And if you go in for a 30-year, fixed-rate mortgage, you will find it even cheaper than the credit line. So now, you are left with just a couple of options. You can keep the credit line, pay it off and replace it with a fixed-rate home equity loan, or do a cash-out refinance on the first-lien mortgage and pay off the credit line with the proceeds. The benefit of opting to keep the credit line is that you will be able to pay interest on the amount owed and nothing more. If however, you can stand the higher payments, it might be better to refinance the credit line into a fixed-rate home equity loan. At present, the rates on home equity loans are roughly the same as those on home equity lines of credit.

Home-equity loan deduction

This is a query that most people have: how do you calculate the percentage of interest that is tax deductible on your home equity loan. Well let’s give you a lowdown on how exactly you cold do it. First a little information – there are quite a few variables that you must consider while calculating the proper amount of deductible interest on mortgage or home-equity loans. These variables include your filing status, the fair-market value of your home, origination dates of previous mortgages and remaining debt.

One of the first things you will need to do is get the IRS Publication 936, Home Mortgage Interest Deductions. This book will give you a thorough explanation of how such calculations are made. It also includes a flowchart to help determine if all or part of your mortgage or equity interest is deductible. You can either pick up a copy of the book or download one. Thestate.com reports:

The second thing you might consider getting is a good accountant.

Read more: Home-equity loan deduction can be tricky

Are rising home equity loan rates affecting the economy?

Interest rates are hitting the skies – especially in the case of home-equity loans. So, what impact do these rising interest rates have on the economy? According to some experts, interest rates act like a throttle on economic expansion because they make it more expensive to borrow money. Sfgate.com reports:

Some experts say the pace of increases has been so measured and the economy is so strong that the impact will be minimal. Others see high interest rates as the prologue to a slowdown or even a recession.

Read more: How rising rates could affect economy

Check these options on home equity lines

Do you have a home equity line of credit? If yes, then you are probably wondering whether you should keep the credit line, even though the rate has almost doubled in 21 months or refinance it. It is a pretty tricky and confusing question. You may have to resort to some math to find the correct solution to your problem. Until two years ago, home equity lines of credit were great deals. You the homeowner, had access to money at rates that were lower than those on fixed-rate home equity loans or first-lien mortgages.

However, the fact that credit lines are indexed to the prime rate meant that the good times couldn’t continue forever. Every time the Federal Reserve raises short-term rates, borrowers' minimum monthly payments go up. Since 2004, the rates have been raised so many times that now the prime rate has gone up from 4 percent to 7.75 percent! Sunherald.com reports:

Borrowers now have three options: keep the credit line, pay it off and replace it with a fixed-rate home equity loan, or do a cash-out refinance on the first-lien mortgage and pay off the credit line with the proceeds.

Read more: Three options to consider with a home equity line

Home equity loan industry fraught with frauds: FTC

Home equity loans are one of the most popular type of loan facility available today and most people still borrow loans on their homes for purposes like funding a child’s college education or refurbishing the home and other needs. And the reason is not far to seek. Home equity loans offer some of the best terms in the industry – interest rates are still much lower than that for other loans. Because of this, many people are now even borrowing against their homes for holidays or for buying gifts for friends and relatives. I know this sounds ridiculous but that is what happens when you can get a loan for almost negligible interest.

Because this industry is so lucrative and the prospects are mind numbing, you must be especially careful and beware of the many frauds and other problems that are associated with some lenders. This warning is directed especially at people with a bad credit, since they are very vulnerable. And these frauds have bored so deep into the system that the Federal Trade Commission (FTC) was forced to issue a warning to people urging them to be aware of such loan practices. If you don’t take heed, you may end up losing your home, it warned.

I know it sounds scary and you begin to wonder if you could actually trust anybody. But a few simple tricks will ensure that you aren’t conned. When you plan to borrow, try to keep a cool head and find out if the lender you approach is credible. Some lenders try to ‘steal’ your equity by asking you to pad your income in order to qualify for a loan. Why do they do this? Because if you have a bad credit history, it is possible that at some point of time, you will be unable to make your payments. The lender is waiting for just such a moment to foreclose your home and take away your equity. There may be hidden costs associated with the foreclosure or you may be forced to pay exorbitant prepayment penalties. Don’t indulge such lenders and always read the fine print before you sign any documents.

Do you know the details of home equity loans?

Yesterday, I explained in short the difference between home-equity loans and Heloc or home equity-based lines of credit. While these loans are excellent and offer a much lower interest than other types of loans, it would be helpful to you if you study these loans in detail before taking the plunge. Timesleader.com reports:

If you’re thinking about a home-equity loan, consider when you will need the money and how soon you will be able to repay it. Rising interest rates favor the fixed-rate terms of home-equity loans (now about 7.8 percent), but lines of credit may still be better for incremental expenditures like college since you pay interest only on the outstanding balance.

Read more: It pays to study details of home equity loans

Home equity loan or HELOC? The choice is yours

Now that we’ve begun to understand home equity loans and how they work, let us now expand our sphere of knowledge on this issue. One of the first things you need to know is that there are two main lines of credit in home equity: Home equity loans and a home equity line of credit, or HELOC. To put it simply, HELOC is a variable-rate loan, whose rate is typically priced at a certain margin higher than the prime rate.

Meanwhile, a home equity loan is both a fixed-rate loan and a self-amortizing loan. That means that the monthly payment is large enough to both cover the interest expense and pay down the principal balance over the life of the loan. Both these loans are second mortgages. In case you cannot decide which line of credit is right for you, you should first be able to answer a few questions: Is the loan right for you depending on what you plan to do with the money. Also try to find our your level of flexibility in your monthly spending and the terms of the two loans.