Why are home equity loans a popular choice as a quick cash source?

There are two main reasons that home equity loans are popular, especially as a quick cash source: attractive interest rates and tax deductibility.

Interest rates on home equity loans are generally low, even if you have bad credit. This is because you are securing your loan with your home and your lender considers this a low risk investment. You aren't likely to try to hide your home, like you could a car, electronics or furniture if you default on your loan, nor are you likely to disappear with your home on the line. For those with poor or bad credit, this type of loan is great for rebuilding your credit score. Interest rates generally range from 5% to 9% depending on your credit score, your area, and the lender you apply through. The interest rate you can get on a home equity loan is lower than a credit card or auto loan, though not as good a rate as a primary mortgage.

You generally don't get tax deductions for taking out a loan, but a home equity loan works a little differently. Regardless of the way your home equity loan is used, the interest you pay on the first $100,000 is tax deductible, so if you pay $2000 in interest on your home equity loan, your taxable income at the end of the year is reduced by $2000. Any other quick cash source does not have this great feature. On top of the loan's interest being deductible, if you use the loan for home improvement, or to buy another home, you can deduct the interest paid on the first $1 million that you borrow. If you take out a home equity loan, see a tax adviser to determine what can be deducted.

Is there more than one type of home equity loans?

There are three different types of home equity loans, each with distinct features that set it apart from the other two. The three types are the standard home equity loan, a home equity line of credit, and a cash-out refinance.

The standard home equity loan is also known as a term loan, closed-end loan, or second mortgage installment payment. It works like a traditional loan. You receive a certain amount of cash then pay it back in monthly installments at a fixed interest rate. Since the interest rate is fixed, so are the monthly payments, which makes it easier for you to budget.

A home equity line of credit works like any other line of credit. You are granted a limit as to what you can borrow, and you draw money out of a special account as you need it. You only pay interest on what you have actually withdrawn rather than the whole sum of what you could borrow, but the interest rate is variable over the life of the loan, meaning that the interest rate fluctuates with market conditions. Occasionally a fixed interest rate can be negotiated on a home equity line of credit, so if you would prefer your interest rate to be fixed, be sure to pursue this option. A home equity line of credit is a revolving line of credit much like a credit card where you can borrow money, pay it off then re-borrow more money. You access the home equity line of credit funds through specially issued checks or credit cards.

A cash-out refinance is not a home equity loan itself, but you use the cash from it as a home equity loan. In a cash-out refinance, you basically take out a second mortgage on your home that is greater than what you owe on your first mortgage. You then pay off your first mortgage and the money left over is used as a home equity loan. The interest rate on a cash-out refinance is generally lower than on a standard home equity loan, but the closing costs are higher. This is a great way to take out a home equity loan if you want to get a lower interest rate on your current mortgage at the same time.

How much can you get from a home equity loan?

Lenders generally let you borrow from your home's equity until you have reached a loan-to-value (LTV) ratio of 80%. To get the LTV take the total amount you have borrowed (both in a mortgage and a home equity loan) divided by the current fair-market value of your home. Some lenders will allow you to borrow as much as 125% LTV, but be careful of these loans as the interest rate is higher as this type of loan poses a higher risk for the lender. If the lender is giving you 125% of what your home is worth, they may loose a good deal of money if you default on your loan even though the loan is secured by your home.

What will a home equity loan cost you?

A home equity loan can cost you quite a bit in fees and closing costs, which is a detriment to using it as a quick cash source. Many lenders may advertise no closing costs, but they make up the difference in interest rates and fees. The fees you pay for taking out a home equity loan are similar to the fees you pay when purchasing a home. The total amount of closing costs and fees for most home equity loans can total 2% to 5% of the loan. Fees that are typically included are as follows:

• Property appraisal
• Application
• Title Search
• Attorney or title agent
• Document preparation

For almost every home equity loan, there will be a fee to appraise your property's value. There are less expensive options than having a professional appraiser inspect the property, so be sure to find out how your lender goes about the process so you aren't charged more than you should be.

The biggest cost to you on a home equity loan will be the interest you pay on the loan. Be sure to figure out how much interest you will be paying over the life of the loan if you interest rate is fixed, or how much you could be paying if it is variable so you can be sure you can afford the loan. Most variable rates have a cap as to how much they can rise over a twelve month period, so you should always figure your interest at the highest rate it could possibly be when looking at taking out a loan with a variable interest rate.

What do lenders look for when you seek a home equity loan?

Lenders look at three things when they are considering you for a home equity loan: your credit history, your income, and the loan-to-value ratio.

The biggest factor affecting whether you will be approved for a home equity loan or not, is your credit history. The higher your credit score is, the better your chances for approval and the better the terms for your loan will be. Be sure to check your credit report periodically for problems and resolve them so when a situation comes up that you need cash quickly, you won't be surprised by what's on your credit report.

The second thing lenders look at when approving a home equity loan is your income. This includes how long you've been at your current job, how long you've been in your field of work, your debt-to-income ratio, and your tax return information. They want to make sure that if they lend you money, it will not put to high of a financial strain on your budget or that you are in danger of loosing your income.

The final factor lenders look at is your LTV, or loan-to-value ratio. If this value is to high a risk for them, they won't loan to you. If your home is worth $100,000 at fair-market value and you owe $80,000 on your mortgage, you aren't likely to be approved for a home equity loan, and if you are approved, it will be at a much higher interest rate than if you owed less on your home.