Many homeowners take out home equity loans to consolidate debts or finance home improvements. The difference between the amount owed on an existing mortgage and a home’s market value is considered available equity and serves as collateral for home equity loans.
There are two main types of home equity loans. The first is the standard home equity loan, where you borrow a single lump sum. The second is a home equity line of credit, or HELOC, where the lender authorizes you to borrow smaller sums as needed, up to a certain fixed amount.
The type you choose depends on why you need the money. If you are looking at a single, major expense – such as redoing a kitchen – a standard home equity loan is usually the best way to go. You can get these as either a fixed or adjustable rate loan, to be repaid over a predetermined length of time, up to 30 years. With a HELOC, you’re given a predetermined limit you are allowed to borrow against as you wish. You only pay interest on what you actually borrow and don’t have to begin repaying the loan until a certain period of time, known as the draw (typically 10 years), has elapsed.
Home equity loans have a couple of advantages. First, the interest rate is usually much lower than the rates charged on credit cards, car loans, or other consumer loans. Second, the interest you pay can be tax deductible as an itemized deduction.
The combination of a lower interest rate plus tax deductibility is attractive. Because of the lower interest rate on the home equity loan, you’ll have a lower monthly bill if you take out such a loan and use the proceeds to pay off your credit card debit or high-interest consumer loans. In addition, you’ll also obtain a valuable tax deduction that will lower your tax bill come tax time.
It is important to understand, however, that your ability to deduct the interest is not unlimited. Only the interest on a home equity loan of up to $100,000 is deductible. Interest on home acquisition loans of up to $1 million is deductible. Thus, you can deduct the interest on a total of $1.1 million in home loans each year.
Written by Kate Aultz