Financial Planning for Businesses

A Few Basic Uses of Home Equity

Not everyone is comfortable with using home equity to help build a retirement fund, so I figured I’d take some time out to get back to basics once again. Let’s start by answering the question, “What is home equity?” Home equity is the value given to a home after you subtract the mortgage debt and any other charges or liens against the home.

Basically, if you bought your home for $80,000 and have paid $40,000 of the mortgage off, you have no outstanding debts toward the home and your home now appraises for $100,000, you would have built up a total of $60,000 in home equity.

Home equity is a somewhat popular way (I guess) to establish a substantial credit line or loan. Do you have a child going to college, need a small business loan, have a lot of credit card debt or large car payments? Your mortgage broker will love you. Borrowing from your equity, using a home equity loan, lets you use your home to pay off high interest debts or make a substantial investment that you may have otherwise never been able to do.

Before you run down to your bank, though, I think you should have some questions ready for your mortgage guy:

  • What kind of loan is it? Your mortgage lender may set you up with a HELOC (home equity line of credit–which is like a credit card using your home equity as the credit line) or an amortizing mortgage (a mortgage with a set payment and payoff schedule).
  • How much money is available to borrow? (Depending on individual credit history, some lenders may allow you to borrow up to 85% or more of the appraised value of your home).
  • Is the interest rate fixed or a variable rate? (HINT: HELOCs are usually a variable rate)
  • What fees are being charged? It’s generally a good idea to know what you’re being charged on the loan (just a suggestion). Obtain a list of all the fees that will be charged in addition to the interest. Lenders may require payment only on the interest until the account closes or they may have a minimum monthly payment.
  • Are there refinancing options? If you take out a HELOC, it may be possible to re-negotiate with the lender to extend the life of the account or convert it to a fixed term loan when the HELOC’s revolving credit account is scheduled to close.

In addition to getting a credit line for a large expense, the interest paid on a home equity loan may be tax deductible for loans up to 100% of the home’s value. With that said, I’m not a mortgage or tax specialist. You should check with a tax advisor, but I think this tax break may make the effective interest cost less than other kinds of loans if you’re able to deduct the interest.

December 6th, 2011 | by David | No Comments

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