Using Your Home Equity Prudently

Home equity loans let you borrow using the equity you’ve built up in your home as collateral. You can often borrow more money at a lower interest rate than with other types of loans. And, in many cases, you can deduct the interest you pay on the loan when you file your tax return, reducing the actual cost of borrowing still further. Most of the other interest you pay, on car loans or personal loans, for example, isn’t deductible. With the new tax law they may be limitations on tax deductibility.

With a home equity loan, you borrow a lump sum, usually at a variable rate of interest, although some fixed-rate loans are available. You pay off the debt in installments, just as you repay your mortgage, with some of each payment going toward the interest you owe and the rest toward the principal, or loan amount. At the end of its term, or payment period, the loan is retired.

You may have to pay closing costs on your loan, just as you did for your first, or primary, mortgage. But lenders may offer loans with no up-front expenses as part of a promotional deal. You might also be offered a teaser rate, or a period of low interest as an incentive to borrow. If that’s the case, the lender has to tell you the actual cost, or annual percentage rate (APR), and when the temporary rate ends.

Home equity lines of credit are actually revolving credit arrangements, which you can use in much the same way you use a credit card. Your credit line, or limit, is fixed, and you can write a check for any amount up to that limit. Whatever you borrow reduces what’s available until you repay. Then you can use it again. The terms of repayment vary, and are spelled out in your agreement. In some cases you begin to repay principal and interest as soon as you borrow, or activate the line. In others, you pay interest only, with a balloon, or one-time full payment of principal, due at some set date. Or, you may make interest-only payments for a specific period, and then begin to pay principal as well. 
Most credit lines have an access period, often five to ten years, during which you can borrow, and a longer payback period. The longer you take to repay, the more expensive it is to borrow. Do the math and weight the value of the purchase before borrowing against one of your most precious assets.

Contributions from the book Credit & Borrowing in this press release are used with permission from Light Bulb Press.