Money always seems to be tight around the holidays. That's why a
lot of people start thinking about a home equity loan or cash-out
refinance this time of year.
To be sure, borrowing against your home equity isn't as popular
as it was a few years ago. And taking out a home loan just to buy a
bunch of snazzy Christmas presents is simply a bad idea. But still,
there are a number of valid reasons why you might want to take out
such a loan at this time of year.
Maybe you need the money to pay your taxes in the coming year.
Maybe you want to consolidate your debts by year's end. Or maybe
the Christmas gift you have in mind is a new kitchen or other home
improvement that will enhance the value of your home, in addition
to pleasing your spouse and family.
Home equity borrowing is actually making a bit of a comeback,
thanks to rising home values in many parts of the country. People
who may not have been able to qualify for a loan a few years ago
now have a bit of equity to work with again. Banks are also getting
more comfortable making such loans as the housing market recovers
and home values firm up.
If you're looking to go this route, what kind of loan should you
get? When borrowing against your home equity, you basically have
three options, four if you're age 62 or older. 1) a home equity
loan, 2) home equity line of credit, or HELOC, 3) cash-out
refinance or 4) a reverse mortgage if you're age 62 or above.
Each has its advantages and disadvantages, and the type you
choose will be based what's the best fit for your
Home equity loan
A home equity loan
is basically a second mortgage you take out on your home. Let's say
your home is worth $250,000, you owe $150,000 on your mortgage and
you take out a home equity loan for $20,000. You now have two
mortgages backed by your home, one for $150,000 and one for
A home equity loan can be a convenient and affordable way to
borrow. The interest rates you can get are lower than those on an
unsecured loan and for most homeowners are tax-deductable as well,
since they're considered mortgage interest. The closing fees are
considerably less than for a cash-out refinance, since it's a
smaller loan amount, and the repayment period is typically about 10
years or less.
Home equity loans are useful if you need to borrow a lump sum of
money for a particular purpose. You can use the money for whatever
you wish - some of the more common purposes are home improvements,
educational costs, medical bills or investing in a business.
home equity line of credit (HELOC)
is a type of home equity loan. But instead of borrowing a lump sum
of money, the lender authorizes you to borrow up to a certain
amount, which you can then draw upon as needed.
HELOCs are good for situations where you're going to need
various amounts of cash periodically over a period of time, or if
you're not sure exactly how much you're going to need by the time
you're done. This makes them popular for certain types of home
projects or business enterprises, for example.
Interest rates tend to be higher than on regular home equity
loans, but closing costs are lower or even nonexistent. You
typically have a draw period during which you can borrow against
your line of credit, followed by a repayment schedule similar to a
regular home equity loans. Again, a HELOC is considered a type of
mortgage, so interest is tax-deductable for most borrowers.
is a different kind of beast entirely. With this type of loan,
you're replacing your current mortgage with a new one at higher
balance and pocketing the difference in cash. So in our example
above, if your home is worth $250,000 and you owe $150,000 on your
current mortgage, you might do a cash-out refinance for $170,000
and end up with $20,000.
A cash-out refinance works best if you're currently paying a
higher interest rate than lenders are offering on new mortgages. So
if you're presently paying 5 percent on your mortgage, you might be
able to refinance your mortgage at 4 percent while borrowing an
additional $20,000 (per the example) at the same rate - it's all
rolled into your new mortgage balance. And you can use the money
for any purpose you wish.
The downside of a cash-out refinance is that the fees are much
higher than a home equity loan. That's because fees are based on
the loan amount and you're taking out a new loan to cover your
entire mortgage. But the rates are lower than on a home equity
loan. The payments are also stretched out over 30 years or whatever
length you chose for the new mortgage, which makes it useful for
borrowing larger sums of money.
Home Equity Conversion Mortgage (HECM
), is a specialized type of loan for homeowners age 62 and above.
With these, you can either borrow in a lump sum or receive money
paid out over time. They key feature, though, is that you don't
have to pay the loan back as long as you live in the home.
A reverse mortgage is still a loan, it's just that the fees,
outlays and interest are charged against the value of the home
rather than you paying for them out of your pocket. The bill comes
due when you eventually vacate the property and is typically paid
through the sale of the home, with anything left over going to you
or your heirs.
Reverse mortgages can be attractive for persons on a fixed
income. However, the interest and fees tend to be higher than on
other types of home equity borrowing. That means you could burn
through your home equity faster than if you took out a more
traditional type of home equity loan that had to be repaid, leaving
you or your estate with less money when you eventually leave the
These are fairly complex financial packages and it is strongly
recommended that you consult with a disinterested financial adviser
before committing to one.
For most types of home equity loans, the most you can borrow is
up to 75-85 percent of your home value, though some lenders may go
as high as 90. That's based on the combined value of your existing
mortgage and the amount of your home equity loan or line of credit,
or the amount of your new mortgage in a cash-out refinance. On a
reverse mortgage, you can actually exceed the value of your home if
you choose to be paid in a fixed annuity, although your debt
liability can never exceed what your home is worth.
It also should be noted that while mortgage interest is
currently deductable for most homeowners, that deduction may soon
be limited by Congress as part of the fiscal cliff negotiations, at
least for high-income or high-value homeowners.
This article was originally published on MortgageLoan.com at: