Is a Home Equity Loan a Good Idea?

First, what is a home equity loan? Well a home-equity loan is a second lien against your home’s equity.I always consider my home equity as a safety net for those difficult times, such as, a job loss or family illness. My rule of thumb for debt management has always been centered on how much equity I had in my house. I would never have my debt exceed my equity.Now let’s get back to the question. Is a home equity loan a good idea? If you manage your money wisely home equity loans are a good idea but only if you spend the proceeds on items that are a necessity and carry a higher interest rate that the home equity loan. A good example would be home improvements or educational needs. These items usually are quite expensive and require long pay-off periods. By using your equity you will be able to write-off your purchase interest on your federal and state taxes. Another example would be to pay-off high interest credit card and personal loans debt but you must make sure that once the debt is paid you can not accumulate any more credit card debt or you will become financially strapped.Below are some guidelines if you’re thinking about borrowing against your home’s value:Don’t waste the cash. Please be aware you’re attaching a new lien on the home, moving closer to the risk of foreclosure. If you do not make your payments on time, the lender has the right to foreclose on your home.Don’t accumulate more debt than you can handle. As I mentioned earlier your total debt should not exceed your homes total equity.Evaluate the tax benefits carefully. Review the IRS Publication 936 for details.Avoid lines of credit unless you have the discipline to make the principal payment on time.In conclusion:It is important to carefully consider how you plan on using the equity in your home. If it is for home improvements, education like college or medical expenses then you are adding even more value to your home and personal growth and well being, which is good. If you are using it for daily spending, vacations, cars or other items that quickly depreciate in value, then you could be risking your nest egg and run the risk of owing money on your home far longer that the average 15-30 year mortgage.

How a Home Equity Loan Rate Is Determined

Lenders consider a number of factors in determining a home equity loan rate. In order to know what rate you may be expected to pay, you will need to have an idea what factors the lender might consider in determining the rate for your home equity loan. This rate varies not only among lenders, but if quite often different among customers.Credit historyOne of the most important factors a lender will use to determine the home equity loan rate for an individual customer is credit history. A negative credit history or insufficient credit history can mean paying a higher interest rate than someone who has sufficient good trades on his credit history. Of course, poor credit will likely not prevent you from acquiring a home equity loan since it is fully secured, but it will most definitely have an effect on the interest rate you will pay.Ratio of loan to appraised valueAnother factor that may have a detrimental effect on the percentage rate is the ratio of loan amount to appraised value. The higher that ratio is, the higher your home equity loan rate will be. In other words, borrowing 70% of your equity will cost you less in interest than borrowing 90%. This may not hold true with all lenders, but many lenders do tie interest rates on a home equity loan to the percentage of equity that is borrowed.Repayment termIn some cases, a lender will offer a more favourable home equity loan rate if you accept a shorter repayment term. This is not always the case, but some lenders do offer it as an incentive to encourage you to pay the loan off sooner. If you accept a shorter payment term, you have the added advantage of paying less interest over the term of the loan, an incentive in itself, especially if you are not in a position to claim the interest as a deduction in tax liability.Financial stabilityThe biggest factor that will affect your home equity loan rate is financial stability as an entirety. This means employment history, credit history, equity in your home, income to loan ratio, and total assets. Some of these factors will be weighed individually, but they will also be weighed as part of your overall financial stability. Like any loan, certain factors are weighed individually, and then combined with other factors to come up with an overall picture of the risk factors in granting the loan.Age and condition of the residenceIn the majority of cases, a lender will charge a higher interest rate for a residence that is quite old or in severe disrepair. It is difficult sometimes to draw the fine line between what is disrepair that can be repaired with a home equity loan and what is severe enough to require a rehabilitation loan to bring the residence into top-notch condition. In either case, the interest rate is going to be higher because the life of the home is shortened due to either age or disrepair.