The second mortgage or a home equity loan is the best way to borrow money by taping your home’s equity. This option became highly popular during the late eighties; however, the Tax Reform Act of 1986 eliminated the deductions for most consumer purchases.
Therefore, you can deduct all interest when filing the tax return with the home equity loan. However, this bliss did not last because the Tax Cuts and Jobs Act of 2017 (enter here to learn more about it) removed this loan from tax deductions unless you use the money for household remodeling.
You can still find numerous reasons to get a home equity loan because it features low-interest rates compared with other options that come in a lump sum. At the same time, you can use the cash for anything you prefer. We can differentiate two types of home equity loans: home equity lines of credit or HELOC and fixed-rate loans.
The interest you pay on equity is tax-deductible, but only if you use it for major repairs and updates. You must repay both options entirely because you will use your house as collateral.
How Do They Work?
Fixed-Rate Loans – You should know that a fixed-rate loan will offer you a lump sum payment you can repay in fifteen years. The amount will remain the same, meaning you can plan everything.
Home Equity Lines of Credit – When it comes to HELOC, you will get a variable or adjustable-rate loan that functions the same way as a credit card. The facts are that you can use it for purchases. You will get pre-approval for a specific spending limit that allows you to withdraw money using special checks or credit cards. Remember that monthly payments vary depending on the amount you decide to borrow and the current interest rate. During a draw period between five and ten years, you can take money out of the equity. However, you will enter a repayment phase after that period, meaning you cannot draw money anymore. Instead, you will have ten to twenty years for repayment. You can convert them to a fixed rate through refinancing, especially if you have an excellent credit score.
Benefits of Home Equity Loans
Use the Equity – You should know that the home is your largest asset, meaning you can take advantage of its value. However, you can tap into the equity you created after on-time mortgage payments when you get a equity loan. Therefore, when a specific time passes and your household’s value increases while the principal decreases, you can use the money for market-related reasons or improvements. That way, you can simplify your spending and streamline your finances.
Boost Your Home’s Value – One of the best things about an equity loan is the ability to boost its value and curb appeal. We are discussing making outdoor and indoor improvements that will offer you high returns, such as bath upgrades, kitchen updates, and adding square footage by finishing the garage apartment, attic, or basement. It would be best to think of it as a short-term personal enjoyment that will offer you long-term resale value.
Improve Home’s Functionality – For instance, you may need an additional infrastructure to boost your situation if you work from your house. At the same time, you may wish to add more space due to reduced mobility issues. Some people want to upgrade into smart houses, which will create an integrated and streamlined system to ensure overall efficiency. It does not matter what you wish to consider because a home equity loan can help you implement it the best way you can.
Create a Multi-Generation Living Options – Suppose you have senior parents who need more help. You can use the loan to create additional options to allow them to live with you. Maybe you wish to convert a specific part of your house by implementing a private entrance and safety features. You can install a tiny house in the backyard for independent living in some cases. You can keep your family close to you and ensure their safety, which is vital to remember.
Tax Advantages – When you use the home equity loan for a improvement project, you can deduct the overall interest when the tax time arrives. Therefore, the best way to spend the lump sum you get is by implementing improvements that will increase overall property value. It is a double-win situation. We recommend you talk with a tax advisor to find the best ways to use your money while ensuring general deductibility.
Investment Opportunity – Another way to use the money is by investing in something that will generate your additional income or cash flow. You can add extra value to your current home. Besides, you can convert the existing area into a new space you can design with rental potential. Suppose your location is in high demand for rentals. In that case, you can use the money to reach a point of higher profit than before.
Buy a Second Home – You should know that buying a second home does not have to be as expensive as it seems, especially if you wish to go away from the town in nature. Therefore, you can use an equity loan to purchase a vacation home where you can go to rest after tedious working days. At the same time, you can take advantage of a townhome for your kids to go to college, while you can use it as an investment property afterward. You will get unlimited possibilities.
Fixed-Rate Interest – You should know that home equity loans (lån with Fjordavisen) come with fixed-rate financing and low interest, meaning you can rest assured and reduce monthly installments to a minimum. It is a better option than getting a personal loan or credit card.
Lump-Sum – Suppose you have an effective plan. You can rest assured because this option comes with a lump sum payment. You can pay everything in installments and work immediately on the process. That will provide you additional flexibility when planning your purchases and investments.
Avoid Using Credit Cards – The best way to prevent significant debt is by taking a loan with low-interest rates that will provide you peace of mind. You can use it to repay your credit card debts, streamlining your payments into a single with low interest.
Understand the Pitfalls
The main problem surrounding the home equity loan is that most people think it is a fast and straightforward solution. However, you can enter the perpetual cycle of spending and borrowing, which will lead you towards more significant debt than before.
This situation is so common that it comes with a term such as “Reloading.” We are talking about creating a habit of taking a loan to repay the existing debt and get the additional money you can spend. As a result, you will enter a spending cycle of debt, especially if you choose the options that will offer you 125% of your home’s equity.
Remember that these options come with more significant fees, meaning you will use your home as collateral. Therefore, you must be as responsible as possible throughout the process.
We recommend you avoid getting a loan worth more than your household because it will affect your future and financial certainty. It is unrealistic to expect that you will be better off by increasing your debt by 125% plus fees and interest. It is the first step towards bankruptcy.
Another problem can happen when you decide to take a loan to finance home improvements. Remember that remodeling your kitchen and bathroom will help you increase the overall value of your home.
However, investing in a swimming pool is not something that will increase its market value. Another popular reason people tap the equity is to pay college education for their children. That way, you will enter your debt without adding value to your home.
Still, if you are near retirement, you should think twice before choosing this solution. It is way better to choose government grants and loans because home equity requires full repayment unless you wish to place your house on the line.
Final Word
It is tempting to use the lump sum and pay for things you do not need. However, you can leverage your home for cash, which will come with certain benefits and risks. It would be best to remember that shelter, food, and clothing are necessities.
The main idea is to avoid pitfalls that lead you into a vicious debt circle. Instead, you should make sure that you can handle the monthly payments before making up your mind.