Guide to Home Equity Loans Chapter: 1 2 3 4 5
Choosing the Right Home Equity Financing
Which second mortgage loan is right for you? You could go with the old eeny-meeny-miny-moe approach, but that's not advisable. Selecting the right debt instrument is a crucial decision, one that can make or break your financial future. Fortunately, answering two simple questions readily reveals the right choice: How do you plan to use the money, and how do you plan to pay it back?
Let's start with some general guidelines:
Table of Content
- 1. Introduction to Home Equity Loans
- 2. Home Equity Lending Lingo
- 3. The Home Equity Family Tree
- 4. Choosing the Right Home Equity Financing
- 5. Funding a Home Equity Loan
- Fixed-rate home equity loans are more suitable for a one-time, fixed expense.
- HELOCs are better for recurring cash needs.
- Home equity loans often have higher monthly payment requirements, and fit better with borrowers who have steady cash flow.
- HELOCS have lower monthly payment requirements, and fit well with borrowers whose incomes vary from month to month. The trade-off for lower monthly payments is a more uncertain repayment schedule.
Home equity loans and taxes
Both home equity loans and HELOCs have the persuasive benefit of tax-deductible interest. You can generally deduct the interest paid on the first $100,000. But be careful-if the market value of your home drops below your indebtedness, the allowable deduction might go down as well. Always consult with your tax advisor for the specifics of your situation.
Learning by example
Applying these guidelines to your life should be relatively straightforward. As an example, consider fictional borrower John Smith, a real estate broker who earns a low monthly base salary, plus commissions and quarterly bonuses. John wants to buy his daughter a car. A home equity loan is an appropriate instrument, because he can easily budget for it on a monthly basis, since payments will be fixed.
When John's not showing homes to prospective buyers, he's a do-it-yourselfer who wants to build an addition to his home. Over the eight months it will take him to complete his project, he'll need to purchase about $50,000 in supplies. It doesn't make sense to pay interest on the entire $50,000 from Day 1, when he only needs $10,000 to get his project started. If John chooses a line of credit in the form of a HELOC, he can borrow the $10,000 at closing, and the other amounts as the project unfolds.
You don't have to be John Smith to make the right choice with confidence. If you're still stumped, a trustworthy lender can (and should) provide some additional insight. But now, you're knowledgeable enough to ask the right questions and benefit from the answers.
6.13
