Home equity loans can provide beneficial cash resource for homeowners considering home improvements such as additions, remodeling, modifications for a disabled person, or major appliance replacements. Other big-ticket items might be education expenses, paying closing costs to refinance a mortgage, or consolidating existing high-interest-rate loans such as credit card debts. Paying off expensive debts with a home equity loan can translate into a single monthly payment, usually at a lower interest rate. In addition, the interest is often tax deductible.
“Ask your tax professional if your home equity loan interest will be tax deductible,” recommends REALTOR ® Janet Matthews, owner of Charlottesville Town and Country. “While mortgage interest is almost always deductible, be sure that home-equity loan interest is. This question is particularly important for first-time home buyers, but should be asked by every consumer in the lending marketplace, because such matters have a direct bearing on their financial well being.”
What is a home equity loan?
A home’s equity, of course, is its market value less the balance of the mortgage and any other existing loans where the property is the collateral. Equity loans take two forms. One is an outright loan that provides a lump sum, generally at a fixed rate for a fixed term. The other is a Home Equity Line of Credit (usually abbreviated to HELOC and pronounced HE-lock) that provides money as needed and often has a variable interest rate that may change during the term of the loan because it is tied to the prime lending rate.
Both loans have additional costs such as appraisals, origination and title fees, pre-payment fees, and closing costs. “Closing costs can be a significant variable whether you are working with a bank, credit union, or a mortgage broker,” explains Matthews. “When doing your comparison shopping, always deal with a reputable institution or company and ask about closing costs and points up front. Sometimes lenders will pay a portion of the closing costs.”
With an outright loan, people can usually borrow up to 90 percent of the equity (not the market value) of an owner-occupied home and about 70 percent for non-owner-occupied property. A repayment schedule is established, so costs are regular and predictable.
Line-of-credit loans are useful for providing ready credit for needs that don’t require a large one-time payment. Proceeds might be used for long-term renovation projects, college tuition payments, or any other large expense that can be paid off in a relatively short time. In this case, the borrower can choose when and how much to borrow. “The advantage of HELOCs,” notes Matthews, “is that they are flexible and you don’t have to reapply to access your funding.”
A credit limit is established and borrowers can use any part of it at any time. Repayment is due only on the outstanding amount on the loan, not the total available, so the money can be used, paid back in partially or in full, and then borrowed again when needed.
Again, the interest may be tax deductible and often interest rates are lower than those for an outright loan. On the other hand, HELOC rates may climb rather than being locked in.
Interest rates depend on the repayment option chosen by the borrower. HELOC closing costs are generally lower than closing costs on either a mortgage or an outright home equity loan. In addition, it’s not unusual for the borrower be allowed to make full repayment at any time without penalty or to just pay the interest for a period of time.
Home equity lending rates in our region depend on individual situations including the loan size, the borrower’s credit profile, and whether it’s a first or second lien.
Homeowners taking out an equity loan must realize they are taking equity out of the home, decreasing its value. “Be particularly sure a home equity loan does not put you ‘upside down’ in your house meaning you owe more than property is worth,” urges REALTOR ® Matthews. “In the case of a recession, many people get caught out under those circumstances so always be conservative in seeking any kind of financing because failure to repay a home equity loan could result in foreclosure.”
Home equity loans make the most sense when the money is used to improve the home itself, thus increasing its value. On the other hand, such loans are seldom a good way to buy things that do not create lasting value such as a fancy vacation or a new car. Still, for people who handle their finances well, home equity loans can be a practical low-interest way to free up money for expenses.
Marilyn Pribus lives in Albemarle County near Charlottesville with her husband and their dog.