Learn all about Home Equity Loans, the standard
"Home Equity Loan" and the "Home Equity Line
of Credit"

Definition
Home equity is the current market value of a home minus the
remaining mortgage balance.  It is essentially the amount of
the home that you own outright.  For example, if your home is worth
$250,000 and the principal balance remaining on your mortgage is
$175,000, then your home equity portion of your home is $75,000.
By using the equity in your home, you may qualify for a sizable
amount of credit at an interest rate that is relatively low.

Typically, residential property is bought through a mortgage, which
is then paid off over a number of years, often 15 or 30.  After the
mortgage has been fully repaid, the property then belongs to the
mortgagor (the borrower in a mortgage agreement), namely the
buyer.  In the interim, however, the buyer simply builds up equity in
the home.  This is what a home equity loan borrows against. 
Although that equity cannot be sold, banks will lend money against
it. 


Home Equity Loans
There are two main types of home equity loans:

1)  A second mortgage, commonly known as a traditional
    home equity loan
2)  Home equity line of credit


Home Equity Tax Break
These two types of loans offer significant tax savings due to the
fact that the interest paid on them is tax deductible.  Interest on
credit card and other consumer debt is "personal" interest that is
not deductible.  If you were to consolidate these loans into a home
equity loan, the interest you pay is transformed into deductible
home mortgage interest. 

To qualify to get the tax deductions for the interest on your home
equity loan, the loan must be "home equity indebtedness".  This is
a mortgage that meets the following two requirements:
  1. The home equity loan must be secured by a mortgage either
    on your principal residence or a second home you select for
    purposes of getting the interest deduction. 
  2. The total amount that may qualify as home equity indebtedness,
    on a principal residence and second home combined, cannot
    exceed $100,000, or $50,000 if married filing separately.

Home Equity Recommendations
If you are curious about a home equity loan, Real Estate Owner
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Home Equity Credit Limit
Lenders generally set the credit limit on a home equity loan by
taking a percentage, 80% for example, of the appraised value of
the home, reduced by the balance owed on the mortgage.  For
example, if your home is worth $250,000 and the balance of the
mortgage on your home is $150,000, you might be able to get a
$50,000 home equity mortgage determined as follows:
 

Value of home                                  $
Credit limit percentage

Adjusted appraised value           $
Less mortgage debt

Potential home equity loan          $		 250,000
       x 80%
------------
200,000
150,000

  50,000

See more home equity loan examples and learn about
the "ceiling rule" (Home Equity Debt higher than your
limit).


Home Equity Debt Limit
There is a limit on the amount of debt that can be treated as home
equity debt.  The total home equity debt on your main home and
second home is limited to the smaller of:
 
  1. $100, 000 ($50,000 if married filing separately), or
     
  2. The total of each home's fair market value (FMV) reduced
    (but not below zero) by the amount of its home acquisition
    debt and grandfathered debt.  Determine the FMV and the
    outstanding home acquisition and grandfathered debt for
    each home on the date that the last debt was secured by
    the home.


Example:  Justin Zimmerman owned a single home that he bought
in 1999 in Ventura, CA.  It's FMV now is $110,000, and the current
balance on his original mortgage (home acquisition debt) is
$95,000.  Bank of America offers Justin a home mortgage loan of
125% of the FMV of the home less any outstanding mortgages or liens.
To consolidate some of his debts, Justin takes out a $42,500 home
mortgage loan [(125% x $110,000) - $95,000] with Bank of America.

Justin's home equity debt is limited to $15,000.  This is the smaller of:
 

  • $100,000 maximum limit
     
  • $15,000, the amount that the FMV of $110,000 exceeds the
    amount of home acquisition debt of $95,000.


Debt Higher Than Limit
Interest on amounts over the home equity debt limit generally is treated
as personal interest and is not deductible.  But if the proceeds of the
loan were used for investment, business, or other deductible purposes,
the interest may be deductible.

Example:  In the example above, Justin cannot deduct the $27,500
($42,500 - $15,000) amount above his limit.  This is treated by the IRS as
personal interest and is not deductible.

 Never Default on Your Home Equity Loan
If you default on a home equity loan, the lender could foreclose on
your home.  You should NEVER agree to a home equity loan if you
can't afford the monthly payments.  If you get in over your head, you
could lose your home. 


Canceling a Home Equity Loan
 Can you cancel a home equity loan?  The answer is yes but there
are rules.  Learn about canceling a home equity loan here





A final note on home equity loans, be aware that when you sell
your home, you probably will be required to pay off your home
equity line in full. 


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