Home Equity Interest

For many people, their home is their biggest asset. More than a physical structure and source of shelter and comfort, it is also a vehicle for significant wealth creation through the buildup of equity. Home equity loans and lines of credit are methods that homeowners can use to tap into that equity.

To understand the concept of equity, a simple example is in order. In 2000, a median priced house cost $127,048. At the end of 2009, it was worth $172,900. If the buyer took out a typical 30 year mortgage for 100% of the purchase price, they would have paid the loan down to $111,452. So, over a period of ten years, this homeowner would have gone from nothing to $61,448 in equity..

There are two types of home equity loans. The first is a simple home equity loan, also known as a second mortgage. In this type of loan, the borrower receives a lump sum of money, secured by their interest in the home, and has to pay it back over time. The second is a home equity line of credit, frequently referred to by its initials as a HELOC, which operates like a credit card. One has the ability to borrow against one’s house at any time, up to a certain limit, but if debt is not taken out, no payments will be due.

Home equity debt of either type is relatively expensive because it is riskier for the bank. If a borrower stops paying on their house and the house goes back to the bank, the holder of the first mortgage will receive all of the proceeds from the sale before the holder of the second mortgage receives anything. If all of the value is used to satisfy the first mortgage, nothing will be left for the second mortgage holder. In the 2010 market, this happens quite frequently.

Because of this, while the national average rate for a 30 year first mortgage is only 5.14%, the average rate for a $30,000 home equity loan is 7.80%. Although the average HELOC rate is also 5.14%, this is artificially low. HELOCs are adjustable, which means that their rate is much more likely to go up than down in the future. In addition to this, many are issued with short-term teaser rates which will expire in as little as one year.

To get the best rate, homeowners should have strong credit and must borrow as little of the total value of their house as possible. Keeping all loans against a property under 80% of the total value can save money. Finally, some lenders will offer a discounted rate for borrowers who allow their payments to be automatically debited from an account at that bank.

Home equity interest can be tax deductible. The interest from loans taken to pay for a house, or for its improvement, is 100% deductible up to a limit of $1,000,000 in debt per married couple. Interest on home equity debt taken out for any other reason is 100% deductible on the first $100,000 in debt per married couple. The limits for singles are half that for a married couple.