Tapping Into Your Home's Equity

by Catherine Rein
(last updated November 13, 2009)

There are times when you might need large amounts of cash, for home improvements or maybe for emergency bills. Using part of your home's equity might be the right choice. There are advantages for using home-equity over other forms of debt such as credit cards. Often the interest paid on the loan is tax deductible.

As you evaluate all the options for tapping your home's equity, keep in mind that you should keep at least a 20% cushion of equity in your home. This will allow you to qualify for lower interest rates, avoid private mortgage insurance (PMI) and other associated fees. Here are three main ways for tapping you home's equity:

  • Home-equity Loans. Home-equity loans are like regular mortgages or car loans. You receive a set amount of money, which you pay back over a fixed number of years at a given interest rate. The equity in your home is used as collateral for the loan. The home-equity loan is generally used with home improvement projects when you know how much the project will cost and you need several years to pay it off.
  • Home-equity Lines of Credit. A home-equity line of credit works more like a credit card. You receive a credit limit that you can borrow against. Home-equity lines of credit have variable interest rates that are typically tied to the prime rate. Home-equity lines of credit are more likely to be used for short-term borrowing, such as for emergencies.
  • Cash-out Refinance. In a cash-out refinance, you refinance your mortgage for a higher dollar amount and receive a check for the equity you are pulling out. You'll need to review the details of a cash-out refinance with a mortgage professional. There may be limits to how much cash you can pull out depending on your home's value and how much equity is available.

Similar to getting your first mortgage, the rate you are offered on a home-equity loan or home-equity line of credit is dependent on your credit score. The higher your credit score the easier it is to shop for a home loan. The lowest interest rates are available to borrowers with credit scores of 760 or better. Lower credit scores will likely result in higher interest rates and higher fees.

You should consult a tax professional for the tax implications of taking a home-equity loan. These types of loans are often thought of as being better than credit card debt, because you can deduct the interest. This is not always the case.

Author Bio

Catherine Rein

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