“Home equity” is a term used to describe the difference between the current appraised value of a borrower’s home and the sum of all liens against it, including mortgages or other deeds of trust. Homeowners with a substantial amount of equity in their homes may be able to use this equity as collateral for loans, which can then be used for a variety of purposes.
Home equity is used most often to meet emergency expenses, such as medical bills or the cost of repairing a property after a disaster. It can also be used to reduce credit card debt or cover down payment assistance on a new property purchase. Homeowners wishing to improve their homes with renovations may use home equity loans or lines of credit in order to pay for the upgrades.
Home equity is also a key component of some retirement plans, such as the Internal Revenue Code’s home-equity conversion mortgage or reverse mortgage. This type of loan allows elderly homeowners to access the equity in their homes while remaining on fixed incomes. The money can be used to pay for health care, finance daily living expenses, or simply to maintain the home. This type of loan must be repaid-with interest on a regular basis until the loan is paid off in full at some point between ages 55 and 95.
Home equity conversion mortgages can also be viewed as an investment option for people nearing retirement age who do not want to spend what little money they have on rent. By converting a portion of their home equity into cash, these homeowners may gain some measure of financial stability in the last years before they retire and stop working.
Another way that people can use home equity is to finance college education expenses through student loans. Although there is no specific type of loan designed for this purpose, many lenders offer low-interest rate loans to people with healthy home equity.
When determining how much money can be borrowed through a home-equity loan, lenders generally require borrowers to have at least 20 percent of the home value left over after subtracting out all other debts. This means that borrowers must have at least 80 percent equity in their homes before they are eligible for a home equity loan.
There are some risks involved with borrowing against home equity, including the fact that if borrowers cannot repay their loans they may lose their homes. There is also the possibility that property values will decline in the future, making it harder to sell homes on which second mortgages have been taken out or increasing monthly mortgage payments because of a higher interest rate.
Homeowners considering this type of loan should carefully consider their options and strive to create a budget that will enable them to repay the debt within the allotted timeframe.
Defaulting on home equity loans can also result in foreclosure proceedings, an outcome which will negatively impact credit scores if the property is sold at public auction to cover mortgage debt. Finally, by using home equity to repay existing debts, borrowers are removing money from their homes, which may also decrease property values in the neighborhood. However, if the loan is used for renovations or other improvements, this could increase local property values when it comes time to sell the home.
Home equity loans are often treated differently than other types of personal loans with regard to taxes. Unlike other types of loans, they are not considered taxable income by the Internal Revenue Service (IRS), which means borrowers can repay their entire loan balance with pre-tax dollars. This tax advantage is an effective way for homeowners to pay down personal debt and rebuild home equity without accruing additional interest charges through the IRS.
Home equity loans are also more flexible than some other types of loans. For example, they can be used to pay for anything related to a borrower’s primary or secondary residence, including ongoing education expenses. This type of loan is especially useful during periods of financial distress when borrowers are not working but still need funds to get by. It may also be used to finance home improvements.
Borrowers must repay loans within a certain time frame, typically ten years. If the loan is not repaid by this point, it will become due and payable in its entirety. There are also prepayment penalties for people who pay off their loans early, which means borrowers may be better off turning to other financing options if they are able to pay off their debt within the allotted time frame.
The interest rate on home equity loans is usually fixed, meaning that it does not change over the course of the loan. People who opt for this type of financing may benefit from lower monthly payments than would be possible with some other types of loans due to this fixed interest rate.
While some lenders will offer no-cost loans, many borrowers must pay closing costs such as appraisal and administrative fees which can affect the total amount of money they will need to borrow. The benefits – including a lower loan amount – may not outweigh paying these expenses unless the borrower has great home equity or is able to negotiate a lower interest rate.
Borrowers may also be able to negotiate a lower interest rate if they have excellent credit, an experienced real estate broker or some other type of professional on their side. For example, some lenders offer reduced rates to people who use the services of specific real estate agencies such as Re/Max and Coldwell Banker.
These agencies often partner with lenders to offer potential home buyers and homeowners lower interest rates on loans in exchange for the increased business that results from the partnership.
Since lenders usually require borrowers to purchase private mortgage insurance before funding the loan, people who do not have sufficient equity in their property may need to increase their down payment amount or buy a second property with a larger down payment. They may also be able to negotiate with the lender to waive this requirement.