A Smarter Way to Borrow for Homeowners
These days money is tight for many us. Most of us are looking for ways to purchase wisely and borrow smartly. Traditional credit cards and personal loans were once the most popular choices when it came to borrowing. Credit cards and personal loans typically have high interest rates and rarely give anything in return. Yes, there are the credit card gimmicks of offering points for dollars you spend or miles for airline travel but, for most of us, those benefits really don't outweigh the costs of the high interest rates and annual fees.
Homeowners have a great advantage when it comes to borrowing smartly. If you have equity in your home, you may be eligible for a Home Equity Line of Credit (HELOC) or Home Equity Loan. These lines or loans typically have lower interest rates and the amount of interest you pay for the year can be deducted from your income tax return. Now those are benefits worth talking about.
Home Equity Line of Credit (HELOC)
Definition:
A HELOC is a line of credit that is revolving much like a credit card but is secured by the equity in your home. It can be used for home improvements, debt consolidation, and other major purchases and expenses. Interest paid on the loan is generally tax deductible. Once the loan is approved, a credit line will be established and you can begin using the funds by writing a check that is provided or by getting a cash advance. The minimum payment due each month is interest only.
Advantages:
• Lower interest rates than traditional credit cards.
• Flexible. Allows you to choose when to use the money plus you may be able to decide when to repay the principal.
• Interest you pay for the year, up to $100,000 can be deducted from your income tax return.
• Can be used for anything from home improvement to debt consolidation, investing, or sending a child through college.
Disadvantages:
• Rates are variable and subject to change depending on the federal rates; monthly payment amounts will vary based upon this.
• There is a draw period (usually 5 to 25 years) and the full amount borrowed will have to be paid back either in a lump sum balloon payment or according to a loan amortization schedule.
• A HELOC is a type of a second mortgage and is secured by the equity in your home. Overextending yourself could cause you to lose your home. Use your line of credit wisely.
Home Equity Loan
Definition:
A Home Equity Loan, sometimes referred to as a second mortgage against your home, allows you to use your home's built-up equity, and is typically used for larger projects in the home. A specified amount of money is loaned in a lump sum for a specific period of time. The interest rate is fixed and the loan usually has to be paid back in 15 years or less. A specific amount has to be borrowed and a set monthly payment is determined.
Advantages:
• The interest rate is usually one of the lowest loan rates a borrower can get.
• Predictable fixed payments.
• Interest you pay for the year, up to $100,000 can be deducted from your income tax return.
• Can be used for home improvements, to pay for a new car, or to finance a child's college education.
Disadvantages:
• A specific amount of money is loaned and you're required to make scheduled monthly repayments of principal and interest.
• Cannot pay down and withdraw additional funds.
• The lender can take possession of the home if the loan isn't repaid.
The Bottom Line:
Whether you are choosing a Home Equity Line of Credit or a Home Equity Loan, you must be aware that each does come with their own set of fees. Some of those fees are negotiable, so be sure to comparison shop and be well informed prior to your application process.
Always read the fine print and definitely look for these terms: pre-payment penalty, credit insurance, and interest rate increase on late payments. If you spot these terms in your loan or line of credit paperwork, be sure to ask for a full explanation as to what these charges mean and how they will affect you.
As always, knowledge is power and that power can save you money.
