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A Home Loan for the Holidays?

Posted: 12/7/2012 6:47:00 PM
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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 circumstances.

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 $20,000.

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.


A 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.

Cash-out refinance

A cash-out refinance 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.

Reverse mortgage

A reverse mortgage , or 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 home.

These are fairly complex financial packages and it is strongly recommended that you consult with a disinterested financial adviser before committing to one.

Final notes

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.

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