Home Equity Loan
Real estate prices across the country have skyrocketed in the last five or six years. Low interest rates, combined with a lack of trust in the stock market has led to a tremendous inflow of capital into real estate. To put that in perspective, take into account the median household income, which is a little over $44,000, and compare that with the national median home price of $216,000, a very high multiple. Of course, in many metropolitan areas where a large fraction of the nation’s population lives, the rise has been even more spectacular. San Francisco has seen the median home price rise from $395,000 in 2000 to $713,000 in early 2005.
For those who did not get in at the right time, the situation is lamentable, many others, on the other hand, find themselves sitting on potential gold mines – in many cases they have witnessed the doubling, trebling or even quadrupling of their investments in a matter of a few years. Walking and sleeping on land that has appreciated under your eyes is a satisfying experience, and some people are quite happy to count their chickens without wanting to cash-in on their gains. Others, for whatever reasons want to enjoy their newfound wealth. Home equity loans offer an opportunity to do just that.
The fact that property prices have risen means that more Americans than ever before are eligible for home equity loans. Let me illustrate that by an example – say you bought a home for $300,000 five years ago, putting down 20% ($60,000) at that time. If you have a typical thirty-year fixed mortgage then you have not made a significant dent in the principal (in this case the loan principal is $240,000) in the first five years. Now suppose, quite realistically in many cases, that the house value has appreciated from $300,000 five years ago to $500,000 today. In this case your equity in the house would have jumped from $60,000 (your down payment) to $260,000 (down payment plus unrealized capital gains). You would be eligible to take a loan against that increased equity. Most institutions are willing to extend home equity credit for upwards of 50% of total equity in the home.
Now that we have established that a rising real estate market has produced many more potential candidates for home equity lines of credit, let us show why this is a financially savvy way of consolidating loans or of securing financing. Whether the reasons are personal, such as Ferrari you have been drooling over, or for your home business, home equity loans are usually the best first option for obtaining liquidity. First, home equity loans take advantage of tax breaks that the federal and state governments give all homeowners – all interest payments made to service the loan are tax exempt. This advantage alone warrants serious consideration – a family in the 30% federal income tax bracket will stand to save a substantial amount on a typical home equity loan.
The implications of the tax advantage are such that many people with no need for additional credit take out home equity loans and invest elsewhere just so they can take advantage of Uncle Sam’s generous handout. Second, home mortgages are handled a little differently from other consumer loans because of two reasons. First, the loan is “secured” by a tangible asset (i.e. the house, comprising of the value of the land and the material with which the house is constructed) and second, there is a huge industry that deals exclusively with home mortgages and home loans, resulting in a fiercely competitive environment. To the consumer, this results in significantly lower interest rates on home loans.
So, let us recap the win-win situation for a home equity line of credit. Rising real estate prices have made more people eligible for bigger loans, in many cases significantly bigger loans than ever before. Relatively low interest rates, thanks to the Fed and a competitive home mortgage industry has kept the cost of borrowing low. And finally federal and state tax breaks on home loans further reduce the cost of borrowing.
If you are thinking of borrowing money and you are a homeowner, be sure to consider a home equity line of credit before pursuing alternative methods of financing.