Home Equity Loans and Lines of Credit

If you own a home and have equity in it, you might consider taking out a home equity loan as a source of funds for your child's private school or college tuition. Alternatively, you might decide to refinance your mortgage to one with a lower interest rate or a longer term in order to create more discretionary income each month that can be used for education purposes. Either way, home equity is an excellent source of financing, especially for larger purchases.

Home Equity Loans

With a home equity line of credit, the lender establishes a credit limit, that you can access as you need (up to the limit), whenever you need it, by writing a check or using your credit card.

With a home equity loan (often referred to as a second mortgage), you borrow a fixed amount (typically no more than 80 percent of the equity in your home), which is transferred to you in full at the time of the closing. You must then repay that amount over a fixed term.

Home equity financing uses the equity in your home to secure a loan. It is structured as either a loan or a line of credit. With a line of credit, the lender establishes a credit limit, which depends on the equity in your home and your ability to make payments. You can then access as much money as you need (up to the limit), whenever you need it, by writing a check or using your credit card. Generally, interest rates are variable and tied to an index. Your monthly payments will also vary, depending on your outstanding balance.

With a home equity loan (often referred to as a second mortgage), you borrow a fixed amount (typically no more than 80 percent of the equity in your home), which is transferred to you in full at the time of the closing. You must then repay that amount over a fixed term. If you repay the loan, the lender discharges your mortgage. If you do not repay the loan, the lender can foreclose on your home to satisfy the debt.

Tip: A home equity loan is more common when you have a single large expense, such as a tuition bill or a house remodeling project.

The advantages of home equity financing include tax-deductible interest and, in most cases, a more favorable interest rate than on an unsecured, personal loan, because your home secures the loan.

The major disadvantage of home equity financing is that your home is at risk because it serves as collateral for the loan. As such, the lender can foreclose on your home if you fail to repay the loan. In addition, you may have to pay closing costs and other fees in order to obtain the loan. However, many lenders may eliminate these costs in an effort to gain your business, so shop around.

How do you know if this strategy is right for you?

Compare the interest rate you can get on a home equity loan or line of credit with the cost to borrow elsewhere to see if home equity financing is advantageous. If you think there is any chance you will have difficulty paying the loan back in the future, you should think twice. A home equity loan or line of credit is secured by your house, and the lender can foreclose on it if you default. To qualify for a home equity loan or mortgage refinancing, you usually need a good credit history.

The decision whether to refinance your mortgage is usually dependent on current mortgage rates. If the current rate is more favorable than the rate of your current mortgage, the decision to refinance will likely hinge on whether you expect to stay in your current home long enough to recoup the costs of refinancing. See Refinancing. You might also choose to refinance to a mortgage with a longer term in order to lower your monthly mortgage payment. For example, you now have a 15-year mortgage but will refinance to a 30-year mortgage.

Caution:  Extending the term of your mortgage will increase the overall cost of your home due to increased interest payments.

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