Advantages & Disadvantages of Taking the Equity Out of Your Home
Home equity refers to the value of your home minus any loans that you owe. Most people start off with very little equity in their home because they have to take out a mortgage to cover the costs. However, over time they begin to build equity in their home as the mortgage is paid off. Many people borrow against the equity in their home to pay for home improvements, tuition or vacations. Home equity loan advantages include the comparatively lower interest rates and tax breaks, but be careful about using your home as collateral.
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Lower Rates
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When you use the equity in your home for a loan, you will pay a much lower interest rate than you would if you took out an unsecured loan or carried a balance on your credit card. If you take out a home equity loan, you can also secure a fixed interest rate for the life of the loan. With a credit card, you usually have a variable interest rate.
Tax Breaks
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When you take out a home equity loan you can deduct the interest on the first $50,000 of the loan ($100,000 if you are married and file a joint return), no matter what you use the proceeds of the loan for. If you use the proceeds of the home equity for home improvements, the Internal Revenue Service (IRS) treats the loan as a mortgage, meaning you can deduct the interest on the first $500,000 ($1 million of you are married and file a joint return). Both of these deductions are itemized deductions, so you must give up the standard deduction to claim them.
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Collateral
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If you take out a home equity loan, you are using your home as collateral. This means that in the event that you fail to repay your debt, the bank can seize your home. If you make your payments on time, this will never come into play. However, if you are using the home equity loan as a way to consolidate significant amounts of debt, you should think twice before putting your home on the line.
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