Home Equity Loan Lowdown

Interest rates make home equity loans unattractive

A short while back, home equity loans and home equity lines of credit were lucrative sources of funds with exceptionally low interest rates. Now, as interest rates rise to unimaginable levels, investors are concerned about what to do with these credit lines. Suntimes.com reports:

Here's a basic rule of thumb: When the HELOC rate gets to 7 percent or more, pay off the line. That's comparable to getting a guaranteed 7-percent-plus rate of return on your investments. (Do note that paying off your HELOC debt doesn't close the line. It will still be available in case of emergencies.)

Read more: Prime rate pulls rug from under home-equity loan

Do you want to keep your home equity line of credit?

If you have a home equity line of credit, you are probably wondering whether you should keep the credit line, or refinance it. This is a pretty tricky and confusing question, since the rate has almost doubled in the past one year. Until two years ago, home equity lines of credit were great deals. Homeowners had access to money at rates that were lower than those on fixed-rate home equity loans or first-lien mortgages.

However, these good times couldn’t have continued for ever. The fact that credit lines are indexed to the prime rate meant that 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! There are very few options before borrowers now. They 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.

Tips to use your home equity

Did you know that Americans have more than $11.2 trillion in home equity! Sounds incredible doesn’t it, especially when you realize that the number of Americans with huge outstanding debts is also quite high. Makes one wonder why we don’t try to use the equity in our homes to repay our debts instead of crying about the lack of money. Well, there are quite a few people who are doing just that.

Since a loan against your home is so beneficial, let us also take a look at the legitimate uses it can be put to. I mean, when you are borrowing money that comes at a lower rate of interest than your credit card, you cannot just go spending it on fancy vacations can you? You must have a plan in place. Here are some tips on how to use your home equity wisely.

Pay off your debts: If you have any outstanding credit card debt, then a home equity loan is a boon to you. Interest rates for credit cards are very high so if your debt is mounting faster than you can say home equity loan, then it’s time you paid of those debts using your lower-interest home equity loan," says Coffin. Just make sure to cut up the credit cards first. But, a word of caution – cancel your card if you cannot check your spending habit. It doesn’t help if you pay off your old debts only to incur new ones.

Home improvements: This is one great investment you can make with your home equity loan. You can upgrade your kitchen, bathroom or even fix your roof. This will help increase the long-term value of you home. But don’t go overboard with your improvements or you may end up pricing your house out of the market.

Be wise with your loan

If you need to borrow against your home’s equity, you should have a plan for repaying your home equity loan even before you borrow. Another thing you should do is shop around for the best deal and use the loan wisely. Axcessnews.com reports:

"Credit card interest rates can be 10 or more percentage points higher than home equity loans or line of credit, so if you are dealing with mounting debt, it can make sense to pay off those credit cards using a lower-interest home equity loan," says Matt Coffin, president and founder of LowerMyBills.com, a free online service where consumers can shop around for the lowest rates on monthly bills and reduce the cost of living.

Read more: Use Your Home Equity Wisely

Avoid home-equity loans for unnecessary expenditure

Have you received a financial aid letter from a college recently which tells you that your offer may come up short? Don’t go in for that home-equity loan yet. I know I’ve made this point earlier, but when it comes to education and higher education especially, people tend to let their hearts lead. So the argument goes that if the extra money that the equity loan brings can see my son/ daughter through college, it’s worth it.

While borrowing against your house is a source for college funding, whether to tap it should be a decision made as carefully as the college choice itself. If you make one wrong move here, you could end up complicating both your tax and retirement situations. And when you begin to think about the irksome things like the alternative minimum tax, you may want to avoid borrowing against your home and would probably want to opt for a conventional college loan instead. Quote.bloomberg.com reports:

Taking out a home-equity loan without thinking about the consequences can get you into trouble. Often offered as lines of credit, these packages are frequently pegged to variable interest rates, which have been rising over the past year.

Read more: Why Home-Equity Loans for College Can Be a Bad Idea: John Wasik

Home equity loans are not for education funding

According to recent research by the Consumer Bankers Association (CBA), an increasing number of homeowners are using the equity on their homes to fund the education of their children. Higher education today has become a costly affair and every bit counts. While helping shoulder the burden of education is a good thing, it should not be at the cost of losing your home. Surprised? Well there are quite a few people who are taking loans against the equity of their homes to fund their children’s education.

The CBA research shows that nearly 5 percent of home equity has been used by homeowners to fund the higher education costs of their children. However, if indications are anything to go by, all this may soon be a thing of the past. As the housing scene witnesses drastic changes, there will definitely be an impact on the home equity loan scene. And consequently, this will lower the number of people taking these loans.

So now that borrowing against equity is no longer a good option, parents may have to look to alternative resources to pay for the college education costs of their children. It may not be such a bad thing altogether since alternative student loans provide loans at very competitive interest rates. They also offer innumerable other benefits, according to Christopher S. Penn, director of AlternativeStudentLoan.com.

The best thing about the loans offered by AlternativeStudentLoan is that parents no longer have to shoulder the increasingly heavy load of college education. In this type of loan, the student is the primary borrower. Private student loans, also have competitive interest rates, no points, no closing costs, no collateral and no out-of-pocket fees or application fees.

Lite Income Documentation for Home Equity Loans from Chase

Chase, one of the nation’s leading home equity lenders recently launched easier income-documentation requirements for home equity loans. This allows brokers and correspondent lenders approved by Chase to help their home equity customers take advantage of this new development. Rismedia.com reports:

Borrowers with a FICO score of 700 or more are eligible for the Lite Income Documentation option for lines or loans up to $350,000. “With Chase home equity lines and loans, originators can further enhance the borrower experience for their best customers,” said Kimberly Salvo, Home Equity National Sales Manager.

Read more: Chase Launches Lite Income Documentation for Home Equity Loans

Tax and home-equity loans

You’ve taken that home-equity loan and it is tax time again. So how do you calculate the percentage of the interest that is tax deductible when filing income tax returns? When calculating the exact amount of deductible interest on home-equity loans, you have to take into consideration a few variables. These include your filing status, the fair-market value of your home, origination dates of previous mortgages and remaining debt.

Another thing you can do is get a copy of IRS Publication 936, Home Mortgage Interest Deductions. This publication will provide you with a detailed explanation of how such calculations are made. It also includes a flowchart that will help you know if all or part of your equity interest is deductible. You can either pick up a copy at your nearest federal building or download one. The next best thing you can do to know your tax-deductible interest is get yourself a good accountant who will help you calculate the exact tax-deductible amount.

Home equity loan industry fraught with frauds: FTC

Home equity loans offer some of the best terms in the industry – interest rates are still much lower than that for other loans. 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.

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. Timesleader.com reports:

Avoid offers to lend you more than 100 percent of your home equity. Interest on the loan above the equity is not tax-deductible and you’ll have even less recourse if you run into money trouble.

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

Shopping for a home equity loan? Beware of frauds

If you are a prospective borrowers, better beware of the many frauds and other problems that are associated with some lenders. If you have a bad credit, you are especially vulnerable. The Federal Trade Commission (FTC) has issued a warning to people urging them to be aware of such loan practices to avoid losing your home. Bestsyndication.com reports:

Loan flipping is another method used to scam prospective barrowers. This entails a lender making an offer soon after you refinanced your home. He may say you can take a bigger loan for a vacation or other reason. If you accept the offer, he will refinance your original loan and then will lend you the additional money. With each new loan, the lender or broker may collect new points or fees.

Read more: Home Equity Loans Pros and Cons - Warnings From The FTC and What to Look For When Shopping For a Home Loan - Bad Credit Refinancing