When you've got a big emergency expense, or want to do something your checking account can't cover, a home equity loan may be a solution. The loan uses the untapped value of your home as collateral. It could save you money, or give you access to credit a lender would not have otherwise extended. The downside is you're putting your home on the line.
House is Collateral
The downside to having your home as collateral is it means your lender can take it to pay off the debt if you default on the loan. The reason for default doesn't matter. If you get sick or loss your job through no fault of your own, you could lose your home. If you use an unsecured loan, all or a portion of your home could be exempt through your state's homestead exemption.
The upside of this move is it immediately qualifies as home equity debt, which is tax deductible. As of 2012, you can deduct the interest on up to $100,000 of home equity debt, or $50,000 if married filing separately. And, if you spend the loan proceeds on home improvements, it counts as mortgage debt. That makes the interest of the first $1 million, or $500,000 if married filing separately, tax deductible.
Lower Interest Rates
On the plus side, home equity loans have lower interest rates than other loans. For example, in October of 2012, the average home equity loan interest rate was 6.25 percent while the average credit card rate was 14.02 percent for fixed rates and 14.57 for variable rate cards. Depending on how much you borrow, it could save you hundreds or thousands per year in interest. For example, over one year, $937.50 in interest accrues at 6.25 percent on a $15,000 home equity loan, while $2,175 accrues on a 14.5 percent credit card.
High loan limits are another benefit of a home equity loan. According to Bankrate.com, lenders typically cap a home equity loan, plus any other debts secured by the house, at 80 percent of the value. For example, if your home is worth $300,000 and you have a $160,000 mortgage, you could borrow up to $80,000 with a home equity loan.
- Bankrate.com: Pros and Cons of Equity Debt
- Legal Consumer: 50 State Homestead Exemptions & Other Bankruptcy Exemptions
- Internal Revenue Service: Publication 936 - Mortgage Interest Deduction
- Wall Street Journal: Home Equity Loans and HELOCs – Getting a Good Deal
- Bankrate.com: Interest Rate Roundup - Home Equity
- Bankrate.com: Interest Rate Roundup - Credit Cards
- Bankrate.com: Home Equity Basis - What Lenders Look For
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."