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Home Equity Loans and HELOCs

by Kevin McKinley - May 17th, 2015

Posted Under: estate planning

We return from a well-deserved break with a continuation of our discussion on mortgages. As you no doubt remember, with interest rates low, valuations picking up, and lenders getting friendlier, there hasn’t been a better time to get a new mortgage in the past several years.

But not every homeowner needs, wants, or can qualify for a new mortgage. So here are some alternative ways to tap your home equity for special expenditures, or just in case.

Home equity loan

Home equity loans are usually for a fixed term (say, ten years), and for a fixed interest rate. The rates are usually a bit higher than the interest rate charged for a traditional 30-year fixed rate mortgage.

According to Bankrate.com, the current average rate for a home equity loan is about 6%, whereas 30-year mortgages are closer to (and in some cases, less than) 4%.

However, home equity loans generally have lower closing costs and fees than what you would incur if you were to get a new traditional mortgage.

When requesting a home equity loan from a lender, it’s usually better to err on the side of requesting “too much”, rather than “not enough”.

Once you qualify for a home equity loan, you receive the proceeds immediately, and the monthly repayments of principal and interest begin.

You can usually use the proceeds however you want, but some ideal reasons to borrow via a home equity loan include undertaking a home remodeling project, or refinancing debt that has a higher interest rate (such as credit card accounts).

Regardless of how you use the loan proceeds, the interest charged on up to $100,000 of a home equity loan can be tax-deductible if you qualify (see Publication 936 at www.irs.gov for more information).

Home equity line of credit (“HELOC”)

The HELOC is a pre-approved ability to borrow against the home equity you have established, at any time and with no additional paperwork or application process, and up to a predetermined amount.

The fees to establish a HELOC are usually less than getting a traditional mortgage, and may be as little as a few hundred dollars. However, some HELOC lenders charge a nominal annual fee to keep the loan open and available to you.

Unlike the home equity loan, the interest rate on a HELOC is usually adjustable, meaning it can go up or down, depending on the benchmark rate used by the lender.

Often the HELOC interest rate can’t rise more than a few percentage points within a given year, and can’t ever go higher than a certain amount.

But if interest rates rise while you have borrowed money via a HELOC, your monthly minimum payments and total interest paid could go up, too.

Another difference from the home equity loan is that once you have the HELOC in place, you can tap it whenever you want, for as much as you want (again, up to the predetermined limit).

Then you only pay interest on the amount borrowed via the HELOC each month, until you decide to pay the HELOC off. Like the home equity line of credit, any interest you pay on the HELOC may be tax-deductible if you qualify.

Generally lenders will allow the HELOC to remain open for several years, and if any amount borrowed isn’t paid off at a certain time, they will help you convert the HELOC to the aforementioned home equity loan, with a new fixed interest rate and payment amount.

Some possible future events that may trigger the need for a HELOC include a potential loss of income due to retirement or unemployment, looming higher education expenses, or a larger purchase that can’t be financed as easily and inexpensively as the terms offered via a HELOC.

Think of getting a HELOC as a form of insurance, in that you can draw from it in a time of financial need without going through the approval process.

And like most forms of insurance, the best time to get a HELOC is before you actually need it.