How Does A Home Equity Loan Work?
A home equity loan is also known as a Home Equity Line of Credit (HELOC.) Let's say you get an appraisal on your home and the appraisal comes in at $150,000. Now, let's say the mortgage you have on your home has an unpaid pricipal balance of $125,000. So, you owe $125,000 on a home that is worth $150.000. Equity is simply a fancy word for ownership, so your equity, or ownership in your home is the difference of $25,000. You can borrow against that ownership.
Why Wouldn't Someone Just Put The Purchase on Their Credit Card?
First of all, the interest on a home equity loan will be much lower than the 15% to 25% that is associated with most credit cards, so it's cheaper to borrow against your home. Secondly, the interest is tax deductible.
However, let's say you're in the 25% tax bracket. That means you'll pay $100 in interest on your home equity loan and save $25 in taxes. This means you're still out $75!
Other Reasons Not To Take Out a HELOC
First of all, it's debt. If you can save for the purchase you would have otherwise bought with your HELOC, you should consider this option. You will no longer have that $25,000 ownership in your home.
Second, unlike credit card debt, which is unsecured, the borrowing against your home is secured. That means there is something attached to your loan (your home) if you don't pay your loan, and the lender can come after that. If you don't pay your credit card, which I would NEVER advise, the credit card company isn't going to come after you for the meal you put on your credit card.
Is it Ever A Good Idea to Get A Home Eqity Loan?
The only time I would suggest getting a HELOC is if you need to make repairs to your home and you plan to stay in your home for at least a few years. I wouldn't use the loan for anything else. Thus, the cost of those repairs will be financed with the home equity loan, which means those repairs will be secured by the loan and nothing else will be secured by it.
Do you have equity in your home and do you need to make repairs? Let us hear from you.