What Is a Home Equity Loan?
A home equity loan is described as being a loan against the value of your home. Home equity is considered the difference between your first mortgage balance and the total value of your home.
As an example, if the total value of your home is $200,000 and your first mortgage balance is $125,000, then your home equity would be $75,000. A home equity loan then would be against this home equity amount or secured by the lender for any loaned amount.
What is the difference between a home equity loan and a home equity line of credit (HELOC)?
A home equity loan differs from a home equity line of credit (HELOC) in that when you borrow the money, the terms of the loan are set as to their interest rate, payment amount, and length of payments due. HELOC’s generally don’t have a set interest rate (referred to as variable interest rate or floating interest rate). They are flexible as to amount of the loan you would use.
In the example above, a lender may be willing to give you a line of credit of $50,000. No payments would be due unless you draw down or use some of your line of credit. You don’t have to borrow the whole $50,000, but use what you need when needed. To the contrary, a home equity loan would be where you borrowed the set amount of $50,000.
Home Equity Loan Rates
Currently, depending upon your credit rating, home equity loan rates vary from 3.625% to 6%. The length of time you have to pay back the loan can vary as well and go as long as 10 to 20 years.
As an example, if you borrowed $50,000 and were able to borrow it for 20 years at 3.625%, your monthly payment would be $293.20 per month. The difference is $65.02 per month, but over 240 payments equals an extra $15,603 in interest paid.
This illustrates a good reason to maintain a good credit rating. The money you borrow can be used for any reason you choose, pay medical bills, pay off higher interest credit cards, to buy a car, or help pay for your children’s college education.
Using Home Equity Loans for Education
According to the credit bureau Experian, student loan debt has increased a whopping 84% from 2008 to 2014. There are over 40 million borrowers with student loans and the total debt exceeds $1.2 trillion. That amount now surpasses home equity loans, HELOC, credit card, and automotive debt. This debt has had a significant impact on home ownership. According to Daniel Haitz of website eduSquared”, home ownership dropped from 33% to 23 % among individuals with student debt at age 30”. Home ownership is one of the driving forces of our national economy, so student debt has had a tremendous impact on our economy.
Parents who want to help their children with their student loans should consider a home equity loan versus student loans for a couple of reasons.
- First of all, student loan interest is tax deductible only to a maximum amount of $2500 per year based on a single taxpayer with adjusted gross income of under $80,000 (married filing joint adjusted gross income limit is $160,000).
- On the other hand, interest paid on home equity loans is tax deductible for all the interest paid as long as you are able to file schedule A deductions which include taxes paid (eg: real estate and sales taxes), mortgage interest, charitable contributions and medical expenses.
Using the home equity loan against your home to pay for college could prove to be more cost effective because of the tax savings achieved.
Home Equity Loan Summary
Obviously, incurring additional debt creates a burden on income, however, if used correctly the net result of using a home equity loan could prove very beneficial. Borrowing for consumption, such as a vacation is not a great idea because you would only have memories to show for your monthly payments.
Using a home equity loan to pay off high interest rate non-deductible interest credit cards could have a significant impact on lowering out of pocket payments, plus significantly lower interest costs and taxes. Using a home equity loan for college or for education is also a nifty idea when it creates a larger tax deduction and a lower, tax deductible interest expense on the money used.