In times of financial struggle its normal to look toward your home's equity as a quick fix. There are certain financial situations that are well suited to using your homes equity and some that aren’t. Let’s take a look at 3 keys to help you use this source of funding to your best advantage.
Some home equity basics can help you begin to evaluate what's best for you. Though home equity may sound complicated, all it means is the difference between what your home is currently worth on today's market and how much money you currently owe on it. Let's take a look at a simple example. If a home is worth $200,000 and still carries a $150,000 balance on the mortgage, then the house currently has $50,000 in equity.
Unfortunately, with some of the large declines in real estate values in parts of the US, some home equity loans are tougher to get. A homeowner whose credit history is good and has some home equity should be able to use the equity in your home as collateral against a loan that contains two key benefits:
- Very low-interest rates. As a general, rule loans like these have interest rates that are normally much lower than things like credit cards or other non-collateral loans.
- Big tax breaks from Uncle Sam. When you file your taxes and get money back it lowers the cost of borrowing even more meaning in many cases you can deduct the interest on as much as $100,000 of the debt carried against your home's equity.
There are basically 2 different ways you can borrow against the equity in your home: You can receive an instant advance of a single sum of money using a home equity loan. This type of loan will have required payments set up over a fixed period of time at a fixed rate of interest.
A home equity line of credit is like an open-ended loan similar to a credit card which you can borrow money as you need it, up to the lender approved amount. Often the rates are variable and then your payments will change because interest rate changes will vary as your balance changes.
It really depends on your personal needs as to which one will be best for you.
A lump sum home equity loan will offer you the security of a fixed rate and fixed payment but you have to take all the money at once. A home equity line of credit offers more future flexibility and if not needed the money will be at the ready without having to make payments until such time as you need it.
In either case, you must use this money wisely. Lenders love home equity interest rates because of the fact that you are putting up your family's home as collateral. But the truth is you can really put your well being at risk if you overspend and cannot make the payments. It stands to reason then that your first thoughts should be on WHY you need the money not on how much you can borrow.
It's important to remember that any debt you take on should be used to improve your financial position or to make a necessary purchase of something that will have lasting value - at least lasting as long as the term to pay back the loan. Using a home equity loan for a new wardrobe, a fancy getaway, lavish gifts, or spur of the moment purchases is not a wise use of this money. It doesn't matter how low your after-tax cost of borrowing is.
Let’s take a look at some wise uses of home equity debt:
Consolidation of current high-interest debt. Bundling multiple balances of different loans into one payment using a home equity loan, you can dramatically lower your interest rates across the board as well as making paying your bills much simpler. However, there is a caveat: You MUST have the discipline to make debt consolidation work. You can end up in considerably worse shape if you turn around and run up all your balances again.
Make improvements to your home. Before taking on any major upgrades to your home you need to think about things like how long you expect to stay in this home and reap the benefits of your investment. In all likelihood, this type of investment would make your home more valuable increasing your equity down the road but keep in mind that a failing market could take all of that away overnight.
Education costs. If college is on the horizon for you or your children then a home equity loan can offer a better alternative than many other sources of funding can. However, take time to look at all the federally sponsored options available today. Be sure to keep in mind you can deduct up to $2,500 in interest from student loans, depending of course on your income. Just be careful to balance that debt against your own needs for financial security or retirement.
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