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Home Equity Loans

Home Equity Loan Home equity is the accumulated value of a home minus the amount still owed on the loan. That means that the longer you have made mortgage payments, the more your equity will have grown. Another factor that increases home equity is the rise or fall in the appraised value of your home.

For example, if you could sell your house for $200,000 and you still owe $60,000, your equity would be $140,000.

This accumulated equity can be used for other types of investments. Letís assume that you want to start a new business. In order to begin you need $25,000 to cover initial expenses. If you donít have that cash, you might have that amount in home equity. You would then contact your lender and apply for a home equity loan. The lender would then calculate your equity and use your home to guarantee the loan.

There is risk, of course. If your investment in the new business fails to produce a return, you will have lost the equity in your house. That means that all those years of paying mortgage payments will be extended even further, along with the interest costs.

Because of the risk involved with backing loans on home equity, you should only use it for solid investments, not for consumable products like cars, furniture and vacations. Remember that your home equity is capital, which is like your financial muscle; the more you protect it, the stronger youíll become. Therefore you should use your capital to produce even more capital, not for products and services that wonít produce a long-term profit.

Several good reasons for home equity loans might be to finance college education, home improvements and expansions, new business ventures, and additional properties. But you need to be sure that these investments will produce a better return than the amount of interest youíll pay on the loan. Otherwise, youíll lose money.

In some rare cases it might be advantageous to use a home equity loan to pay off high-interest debts. A home loanís interest rates might be five or six percent, whereas other forms of debt can burden you with interest rates that are twice that much. In this case, it might make sense to pay the high-interest debts with a low-interest home equity loan. However, you will be converting capital into consumption. And if you lack spending discipline, thereís no guarantee that you wonít dive into consumer debt again. One great advantage of home equity loans is that they are tax-deductible. The limits of how much you can deduct will change depending on federal tax law, so you will want to contact the Internal Revenue Service for the most up-to-date information.

Home Equity Line of Credit

A slightly different twist on home equity loans is the home equity ďline of credit.Ē This is different than a fixed loan with a fixed interest rate. With a line of credit, you use your house as collateral to back up ongoing borrowing capacity. Think of it as a credit card, only without the card. Your house equity will be the bankís guarantee that you will pay back what is owed. Because the bank has that guarantee, you usually get a better interest rate than what a credit card would charge.

With a home equity line of credit, the lender will establish a credit limit based on your equity. They will also establish a time limit, usually not more than 10 years, during which time you are allowed to borrow and pay as you please. However, should you sell the house before the time limit has expired, you will need to pay the full balance of your debt. In most cases, home equity lines of credit have variable interest rates that can go up or down.

The advantage of a home equity line of credit is that it gives you more flexibility than a normal home equity loan. For that reason it can be more dangerous. If the borrower lacks discipline, it might be too easy for him or her to use the credit for consumer spending. If that happens, the borrower is just trading his wealth-producing capital (home equity) into wealth consuming debt.

Author: Glenn McMahan


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