Home Equity Loans
Home equity loans are loans that are secured by the equity in your home. Homeowners can generally borrow up to 80 percent of the market value of their home and must have at least 20 percent in equity of the home's market value. In return, lenders receive a second mortgage on your home.
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Example
Ricky and Lucy own a home that has a market value of $200,000. They have an outstanding mortgage of $100,000 on their home. They have a spotless credit record and would like to tap into some of the equity in their home to add a second floor to their house and buy a small boat. Ricky and Lucy would qualify for a home equity loan of approximately $60,000 ($200,000 market value of the home x 80 percent - $100,000 owed on first mortgage = $60,000).
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The advantage of taking out a home equity loan is that for most people, the equity in their home is the biggest asset they own. Lenders offer attractive and competitive interest rates for loans secured by homes. You can use the money you borrow for whatever purpose you wish. As an added bonus, unlike the interest paid on most other loans, the interest on a home equity loan may be deductible for income tax purposes.
The downside. We know home equity loans sound wonderful, and in a perfect world, they are wonderful. However, remember what your loan is secured by. It is secured by arguably the biggest, best and most important asset and investment you own--your home. If you default on your loan, the lender can foreclose on your home. Always keep in mind that the unexpected does happen, including job losses and illness, and make provisions for covering your home equity loan payments through insurance, savings or whatever means necessary.
Lines of credit. Also available are home equity lines of credit. Home equity lines of credit are when a lender gives you a line of credit (rather than an actual loan) based on the market value of your home and your equity interest. You can then use this line of credit as you see fit and pay it off in increments.
Remember, the same warnings that apply to home equity loans apply to home equity credit lines. If you default on the payments for amounts borrowed on a credit line based on the equity in your home, the lender can foreclose on your home.
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Planning Note
It's a great idea for most people to obtain a home equity line of credit if they are eligible to do so. Why? Well, if you ever need to borrow money at a competitive rate, whether it is for an emergency or some sort of financial opportunity, you can obtain the funds immediately. If you never need to use the credit line, you haven't paid any unnecessary interest or incurred any major financial cost.
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