The Average Home Equity Loan

Home equity loans can be used to renovate a nursery.

Home equity loans allow homeowners to borrow against the value of their home. They come in two types: second mortgages and home equity lines of credit. Most home equity loans are structured as lines of credit. According to the American Community Survey made in 2009 by the U.S. Census, the average home equity loan had a median line of credit of about $50,000. Of that, the median outstanding balance was $26,000. Americans paid a median interest rate of 4.5 percent, with a median monthly payment of $260.

Loan Amount

The amount you are able to borrow may be limited by your credit history and income.

Imagine a house is worth $300,000. The owners have a mortgage balance of $100,000. The remaining $200,000 is the owners' equity. Some banks offer loans using equity as collateral, usually limiting the loan to about 85 percent of the home's value after existing mortgages. For example, 85 percent of $300,000 is $265,000. If the owners of our imaginary home sought a home equity loan, most banks would limit that loan to $165,000 ($265,000 minus the $100,000 still owed).

Types: Line of Credit and Second Mortgage

Home equity loans can made as standard loans that have a fixed duration and payment. These are also known as second mortgages. At the beginning of the loan period, a homeowner is given a lump sum. He pays it back over time. In other cases, home equity loans are structured as lines of credit. Imagine, for example, the owners of the imaginary home are given a line of credit of $50,000 and use the total amount. They make payments for several years so there is a balance of $25,000. They may choose to draw down an additional chunk, maybe $10,000, of the home equity line of credit, increasing their balance by that amount. In most cases, second mortgages come with fixed interest rates, and lines of credit with variable interest rates. As of 2009, about 11 million American homes had more than one mortgage. About 9 million had home equity lines of credit.

Uses

Paying tuition with a home equity loan might make college possible for some.

Home equity loans may be used to repair or add to a home, but their use is not limited to these situations. Some people use home equity loans to purchase cars, pay medical bills or pay college tuition. Interest on a mortgage is tax deductible. According to the IRS, some types of home equity debt may also be tax deductible. IRS Publication 936 details situations in which home equity loans are tax deductible. One advantage is that homeowners can use their line of credit to purchase a car, then claim the interest on that purchase as a tax deduction. Of course, the deduction applies only if you itemize. The danger of this is that the loan can outlive the car.

Considerations

The big risk of home equity loans is getting behind on payments and losing the house to foreclosure.

Home equity loans provide you with a needed source of cash, and the tax advantages are nothing to sneeze at. The big risk is that you can fall behind on the line of credit and lose your home. Imagine, for example, a borrower with $100,000 in equity in a $200,000 house. He takes out a $25,000 loan. In a few years, sick and unable to work, he is unable to pay the home equity bill. If the home is foreclosed on and sold at auction, he may lose all the equity in his home if the auction does not bring in more than the balance of the loans.

Costs

Home equity loans are similar to mortgages in one big respect: it pays to shop around. Different banks may offer significantly different mortgage rates. Some may charge more in up-front fees like closing costs. According to the Federal Trade Commission, "One of the best protections you have is the Federal Truth in Lending Act, which requires lenders to inform you about the terms and costs of the plan at the time you are given an application. Lenders must disclose the APR and payment terms and must inform you of charges to open or use the account, such as an appraisal, a credit report or attorneys' fees. Lenders also must tell you about any variable-rate feature and give you a brochure describing the general features of home equity plans."

References

• IRS: Mortgage Interest Deduction
• Census.gov: American Housing Survey
• Federal Reserve: Home Equity Credit Lines
• Federal Trade Commission: Home Equity Credit Lines