Real Estate Equity Loans
Just as you can borrow against the savings in and cash value life insurance policy, you can also borrow against another asset you may own: real estate. Such loans are called real estate equity loans. A property owner’s equity position in real estate is the amount by which the owner’s interest exceeds the amount owed on the property. Thus a homeowner who owes $80,000 on a home valued at $140,000 has an equity position of $60,000 in the home.
One way of tapping the equity in your home is through a second mortgage. A second mortgage is a loan against the equity in a home that is subordinated (secondary) to the first mortgage of the property in case of default. The first mortgage is the original loan that was made when the home was purchased.
Second mortgages are of shorter duration than first mortgages and are commonly used when a portion of the first mortgage has been retired or when the home has appreciated in value. Second mortgages are installment loans, often with a large payment called a balloon payment at the end of the loan period. Since a second mortgage is riskier than a first mortgage because the claim of the first mortgage lender takes precedence over the claim of the second lender, the interest rate charged on a second mortgage is usually higher than the interest rate on the first mortgage. Common uses of second mortgages are to fund remodeling the home, college education, and business startup costs. A second, more flexible, method of borrowing against the equally in a home is through a home equity loan.
A home equity loan is a line of credit with either a fixed or variable interest rate issued against the equity in a home. A line is similar to a preapproved credit limit on a credit card. The line of credit typically extends for 10 or 15 years, and you can borrow up to the approved limit when you need the money. Equity loan is repaid through flexible monthly payments. One of the major advantages of home equity loans is the favorable tax treatment afforded the interest paid on them. Before the 1980s, interest on many forms of consumer borrowing was a tax deductible expense. Tax law changes in the 1980s eliminated interest deductibility for most types of consumer debt. However, the interest paid on home equity loans remains a tax deductible expense.