Financial Literacy 2007 - Home equity
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home equity
FAQ: borrowing against home equity

Using a home equity loan to buy a car

q_v2.gifWe are looking to buy a used car and trying to think of a better way to finance the purchase. I found out that we could take out a second mortgage, which is tax-deductible, to finance the car purchase versus getting a straight car loan. Is this a good idea? Thanks.
-- Tamara Taps

a_v2.gifFor people who have a fair amount of discipline in how they manage their finances, a home equity loan or home equity line of credit, HELOC, can make perfect sense as a way to finance a car, new or used. If you're struggling with large credit card balances or have problem credit, a home equity loan might not be right for you.

Not everyone can make use of the mortgage-interest deduction when filing his or her income tax return, but if you're using the deduction now on your first mortgage, odds are you'll be able to use it on your home equity loan, too. IRS Publication 936, Home Mortgage Interest Deduction 6, lays it all out. Talk to a tax professional if you're still not sure.

By being able to deduct the interest expense, you reduce the effective rate of interest on the loan. The interest expense on a conventional auto loan isn't tax-deductible. Bankrate's national average for a HELOC as of May 2007, is 8.16 percent and 7.94 percent for a home equity loan. The national average for a three-year auto loan on a used car is 8.46 percent. If you're in the 25-percent marginal federal income tax bracket, the effective rate on the HELOC is about 6 percent.

A HELOC is a variable-rate loan, and the interest rate is normally tied to the prime rate. Since the prime rate moves in lock step with changes in the targeted federal funds rate, and that rate rose steadily for more than two years, it takes a bit of courage to sign up for a HELOC to finance your car.

In contrast, a home equity loan will have a fixed interest rate, and the loan payments are self-amortizing, meaning the payments are large enough to pay the interest expense and pay off the loan over the life of the loan. In the early years of a HELOC, its required loan payments are interest-only, and you have to have the financial discipline to make principal payments, too.

You can use the Bankrate rates home equity rates search tool to comparison-shop for a loan or line of credit.

A car is a depreciating asset. You don't want to take 10 years to pay off the loan on a car that you'll drive for five years. Regardless of which loan you choose, plan on paying off the used car over the time you expect to own it. That way you'll have some equity in the car when you go to buy its successor.

Using refinancing or home equity loans to consolidate deb

q_v2.gifFirst, I don't know much about finances. I have a question. I share a home with my mother. We have a small $9,000 loan on our home. I would like to build a garage and consolidate about $8,000 in credit card debt. Also, my lease is up on my vehicle, and I need another one. Would a home equity loan be the right way to go? Our home is worth around $95,000. With a home equity loan, won't my payments be much less than paying each bill or loan separately? Thank you for any help you can give me.
-- Steven Solidify

a_v2.gifUsing a home equity loan has two advantages over other types of nonmortgage consumer debt. First, since the loan is secured by the equity in your home, the interest rate is typically lower than the interest rate on unsecured debt. Second, if you can use the mortgage interest deduction on your income taxes, the effective interest rate is even lower.

One disadvantage of using home equity loans to consolidate debt is that you spread the debt out over a much longer period, typically 10 to 15 years. Taking 10 years to pay off a car or credit card debt will actually increase the total interest paid, even though the interest rate is lower because of the longer loan term.

Another disadvantage is that many people don't have the discipline to stop using their credit cards, and before they know it their credit card balances are right back to where they were before the debt consolidation. All they gained from debt consolidation is the ability to buy more stuff on credit.

I used Bankrate's mortgage calculator along with some guesstimates on how much you would pay for a new car, a new garage, and how many years you have remaining on the mortgage to come up with a table.

The table shows how extending the loan term reduces the monthly payment. It also shows you how adding additional principal payments to the monthly payment can shave nine years off the 15-year mortgage and dramatically reduce your total interest expense. Even though the table won't match your situation exactly, it provides a framework for you to use in constructing a table to calculate your numbers.

Has home equity funded your dreams or turned into a nightmare? Share your story.

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Use home loan for college costs?

Dear Dr. Don, We have owned our home for five years. It's currently valued at $325,000. We'd like to borrow $50,000 to $70,000 for college costs. Can we take out a second mortgage at a lower interest rate, or must we take... Read more

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