Home Equity Loan FAQ
A home equity loan is an option lenders offer for borrowers who have built up equity in their homes. The lender allows you to borrow a percentage of your home's value and uses the home as collateral in case you fail to pay back the loan. Because the loan is secured, it tends to offer lower interest rates than other borrowing options like credit cards or car loans. Home equity loans usually last 15 years.
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What Can You Borrow For?
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Home equity loans can be used for whatever you want. Many people use home equity loans as consolidation loans because the interest rates are lower. Financial institutions can offer lower rates for home equity loans than for credit cards because the home equity loan uses your home as collateral and credit cards are unsecured loans. Other common uses for home equity loans include home improvements and paying for tuition.
What are the Tax Deductions for Home Equity Loans?
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Home equity loans can help minimize your taxable income. If you use your home equity loan to improve your home, you can deduct the interest on the first $500,000 of the loan if you are single or $1 million if you file a joint return. If you do not use the money for your home, you can only deduct the interest on the first $50,000 if you file a single return or $100,000 if you file a joint return. To claim either of these interest deductions, you have to itemized your deductions which means you cannot claim the standard deduction and you must file using Form 1040.
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How Much Can You Borrow?
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The amount you can borrow depends on how much equity you have in your home and your ability to repay a loan. To calculate how much equity you have in your home, subtract the amount of money you owe on your mortgage, if any, from the value of your home. For example, if your home is worth $230,000 and your mortgage still has $50,000 to be paid off your equity is $180,000. Some lenders do not allow you borrow more than your home is worth, but other lenders will let you borrow up to 125 percent of your home's value.
What is a Home Equity Line of Credit?
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A home equity line of credit functions similarly to the way a credit card works. The financial institution approves you for a maximum amount that you can take out and a fixed number of years that the credit line is available. However, the entire line of credit is not disbursed immediately. Instead, you can take out what you need when you need it and you only pay interest on the amount that you have take out. For example, you may be approved for a $50,000 home equity line of credit but only take out $10,000 when the loan starts.
What is the Downside to a Home Equity Loan?
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One downside to a home equity loan is that because it uses your home as collateral, you could have your house foreclosed on if you fall behind in your payments. If your home equity loan has a variable interest rate, if interest rates rise your monthly payment could increase suddenly.
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