Home Improvement

A home equity loan used for home improvement, repairs or upgrades can give you a tax sheltered way of increasing the market value of your home.

If you make home improvements with the specific intent of increasing your property value, (as opposed to making it more comfortable to live in), make sure that the renovation will add the value you are looking for. For example, a kitchen renovation might recover the money spent and more, where as adding a pool might not.

While a home equity loan in most cases decreases your home equity, when used wisely for home improvements, a home equity loan can actually increase your home equity by increasing the market value of your home beyond the value of the loan.

Debt Consolidation

Using a home equity loan to replace various credit card and other high-interest debt has several advantages. The interest rate you pay on your average home equity loan is lower than the interest rate you will pay on your average credit card by 7% to 10% or more. The interest you pay on a home equity loan is tax deductible where as the interest you pay on credit card debt is not. A single payment on a home equity loan can simplify paying several credit cards with different lenders and staggered payment times.

Let’s say you have $20,000 in credit card debt at 18%. If you are making a monthly payment of $450 (50% more than the minimum payment of $300), it will take you 6 years and 1 month to pay off that debt and you will pay $13,045 in interest. Using a home equity loan at 8%, you can make the same payment and pay off that debt in 4 years and 4 months and pay only $3,732 in interest. This means that you have saved over $9,000 in interest. With the home equity loan scenario, if you are in a 30% tax bracket, you will also save over $1,000 in taxes on the $3,732 you will pay in interest.

A home equity loan can also help make spiraling credit card debt more manageable by spreading out the payments over a longer period of time. If a home equity loan is used for this reason, you should consider the fact that you may be paying more in interest over the long run if you make smaller payments.

When a home equity loan is used for debt consolidation, you should have a plan for how you will avoid incurring future debt.

A home equity loan can be used for anything from paying off high-interest credit card debt, to home improvements to buying a car. The best uses of a home equity loan improve your financial situation, your home or your future and these include debt consolidation, home improvement and education. Your money is invested in something that grows. Poor uses of a home equity loan are to buy a car or to pay for living expenses - the money is spent on something that depreciates or does not create an asset

A lower interest rate and tax deductions are the two major advantages home equity loans have over other types of debt.

Since a home equity loan is secured by your home, it poses less risk to a lender than does a non-secured personal loan or credit cards - this lower risk is passed on to you in the form of a lower interest rate.

The second major advantage is that regardless of the way a home equity loan is used, the interest you pay on the first $100,000 you borrow is tax deductible. Credit cards and other types of non-secured loans do not have this tax benefit. This means that if you pay $3,000 in interest on your home equity loan, you will reduce your taxable income by $3,000 at the end of the year. If you use a home equity loan for home improvements or to buy another home, you can deduct the interest paid on the first $1 million that you borrow. The reason for this is that home improvement loans are similar to first mortgages for tax purposes. You should consult a tax advisor about the specific tax benefits available to you.

The biggest drawback of a home equity loan is the fact that your home is on the line and you could lose your home if you default on your payments. When you borrow from your home’s equity you also reduce the equity or ownership you have in your home. This means that you trade ownership or equity in your home for cash that you will use for some some other purpose. In addition to interest you will pay on the loan, there are also costs associated with taking out a home equity loan - these costs are similar to the costs you paid when you bought your home.