Cashing in on the equity in your home can be a smart financing decision. Home equity mortgage loans secured by your home generally offer lower interest rates and can also provide tax benefits. Just because the home equity mortgage loan is secured by your home does not mean the purpose of your loan has to be tied to your home. There are many reasons borrowers choose to obtain a home equity mortgage loan or home equity line of credit.
According to a recent Consumer Bankers Association report, the top five reasons for borrowing money through a home equity mortgage loan or line of credit are:1. Consolidating debt
2. Making home improvements
3. Purchasing a car
4. Paying for an education
5. Making a major purchase
Many people seek a home equity mortgage for debt consolidation, but think long and hard before you go down that road. In many instances, the debt you wish to consolidate is from credit cards, which is unsecured. If you do not make payments on a credit card, the worst thing that can happen is your credit rating is ruined and you have debt collectors harassing you. Of course, those are serious consequences. But when you roll the debt into a home equity mortgage loan or line of credit, the lender can foreclose on your home.
For those who are consolidating debt and have made lifestyle changes to ensure they do not end up in the same situation again, a home equity mortgage loan can be a good option. The rates are usually lower than most credit card interest rates and the interest is typically tax-deductible. This can equal large savings versus making minimum payments on your credit cards. Of course, this assumes that when you take out the debt consolidation loan, you cut up your credit cards.
In this case, home improvements can increase the value of your home and therefore your equity. The home equity mortgage can allow you to borrow funds to improve your home at low interest rates compared to visiting a home improvement store every weekend and charging the purchases to your credit card. Again, the interest is usually tax-deductible.
In some cases, borrowers have been known to attach their home to purchases such as a car in order to obtain the tax benefit. In this case, the interest paid on the car would qualify as mortgage interest for tax purposes since the home is also used as collateral on the loan.
This type of arrangement allows the borrower to buy a car without having to visit the bank for approval. It may also allow them greater bargaining power with the salesman since the deal is not dependent upon financing. Because the interest rate on a line of credit is variable, this can result in varying car payments. Also, if you pay interest only or a just a small portion of principal on the loan each month, you could end up owing more on the car than it is worth at some point in the future.
Paying For College Tuition
In the case of paying for college tuition, a home equity mortgage can be an excellent option. Because the home equity mortgage is tied to your home, you can reap the tax deduction at year-end from the interest. But once again, you are using your home as collateral, which puts it at risk if for some reason you cannot make the payments.
Home equity lines for the purpose of tuition are often popular with parents who have children close in age and attending college back to back. The line will allow them to make draws as often as necessary to pay for tuition, books and other expenses. Because it is a line and not a fixed loan amount, it is easier to manage and allows for more flexibility.
Keep in mind, there are federal loan programs as well that may offer lower interest rates. These loans are often unsecured meaning you are not putting your house on the line so your child can pursue a college education. But these loans involve a great deal of paperwork and generally have a set maximum. Payment on these loans can be delayed until after college graduation.
Other Major Purchases
The home equity mortgage loan or line of credit generally has no limit on what you can buy with the money. Some borrowers may use the line to pay for major purchases. This could include a motorcycle, boat or an expensive household item such as a flat screen television.
With any of these purchases, it is important to look at the life of the item versus the amount of time you will be paying for it. For instance, if you used your equity line to buy a motorcycle and only paid interest and a small portion of principal over the life of the line, you will still owe a great deal when repayment is due. In all likelihood, you could owe more than the motorcycle is worth. But you have also reaped the tax benefits and lower interest rate during this time that could offset some of the potential cost.
No matter what you decide to use your home equity mortgage loan or line for, be sure to use it wisely. Your home is most likely your largest asset and you should protect it and the equity you have worked so hard to build. It's important to look at the benefits and disadvantages for your individual situation and weigh your options. All in all, cashing in on your home equity can be a financially wise decision.