What Should You Know About Home Equity Lines of Credit?
A home equity line of credit (HELOC) is a credit account that uses the equity in your home as security, according to the Federal Reserve Board website. The advantage of a home equity line of credit is that you only use what you need, as opposed to a home equity loan, in which you receive as a lump sum. Before signing a HELOC agreement, there are some things you should know that will help you understand the arrangement.
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Tax Deductions
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One of the advantages of a HELOC is that the interest you pay is tax deductible, according to George Saenz, writing on the Bankrate website. As of 2011, the IRS website indicates that the interest on up to $100,000 spent on a HELOC is tax-deductible. The money borrowed from a HELOC can be spent on anything you choose. Once you get beyond the $100,000 limit, the interest on what you spend can be deducted, but only if the money is spent on pre-approved purchases such as home improvements. It is best to employ the services of a tax specialist when determining how to write off interest from a HELOC on your taxes.
Interest Rates
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The most common type of interest rate on a HELOC is a variable rate, according to the Federal Reserve Board website. This means the interest rate can fluctuate up or down depending on where the bank sets it. This is different from a fixed rate, which remains constant throughout the term of your obligation. The benefit to a variable interest rate is the potential for lower monthly payments when the interest rates are low. However, a rise in interest rates could make your monthly payments expensive. According to the Shoprate website, you can shop around for a HELOC that offers a cap on the interest rate. This prevents the interest rate from going any higher than a rate agreed upon by you and the bank.
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Amount
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A bank determines the HELOC limit by multiplying your home's value by a percentage, and then subtracting the remaining balance on your mortgage to arrive at a limit, according to the Shoprate website. If the percentage required by the lender is 75 percent -- which is a common figure, according to the Federal Reserve Board -- and your home is worth $100,000, the bank would use $75,000 as possible equity. If you owed $50,000 on your mortgage, your HELOC limit would be the equity minus the mortgage balance, which gives you a HELOC limit of $25,000.
Costs
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Several fees are required when obtaining a HELOC, according to the Federal Reserve Board website. Your home must be appraised to determine its market value, and the appraisal costs money. The bank charges a set-up fee for the HELOC, and you may choose to purchase interest points that can lower your rate. Some of the other costs include attorney's fees, homeowners insurance, title insurance and property taxes. It is similar to the closing costs of buying or refinancing a home.
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