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Chapter 5: Factors to Consider
For some, getting a second or reverse mortgage or refinancing could be the best option, for others, a mistake. Since you are putting one of your most important assets – your house – on the line, it is important to think carefully before acting.

What will the equity be used for?
By using your home’s equity, you are decreasing your wealth and increasing your debt, so make sure you are using the money for a worthwhile purpose. Do you really want to take out a home equity loan so you can go on cruise? Think about what you are planning to use the money for, and if it is worth depleting your home’s equity. Popular uses of home equity include:

  • Consolidating unsecured debt. Unsecured debts, such as credit cards and personal loans, often come with high interest rates. A loan secured by your home will usually have a better interest rate, smaller monthly payments, and the interest may even be tax deductible. Also, if you have many accounts, consolidating them into one payment can make your life much easier. Still, it is important to keep in mind that you are turning unsecured debt into secured debt. If you do not pay your credit cards, your house cannot be taken from you, but it can if you do not pay your home equity loan or line. Sometimes, when people pay off unsecured debt with their homes, they just wind up maxing out their old cards again, giving them more debt than before.

  • Financing home improvements. Perhaps you want to change the cabinets in the kitchen, upgrade the bathroom, or add a whole new room. Home improvements can be expensive, and many people do not have the savings to pay for them. While renovations can increase your enjoyment of the house, as well as its value, people sometimes borrow so much that they cannot make the payments. Think about what you can afford to borrow and what projects can wait if you have limited funds.

  • A source of savings. Many people take out home equity lines in lieu of saving. Why not? The money is there when you need it, and you do not have to pay interest until you withdraw the funds. Unfortunately, it does not always work out. Credit lines can be frozen, meaning you are no longer able to use the funds that were once available to you, or you may not be in a position where you can afford to repay what you borrowed. You could take out the money before you need it and put it in a savings account or invest it, but the money is not really savings, since you need to pay it back. Also, it will cost you if the interest you are charged on the home equity line is higher than the interest you earn from your savings account or investments.

Is the monthly payment affordable?
Never forget, if you cannot make your payments, you can lose your home. If you take out a second mortgage or, in many cases, do a cash-out refinance, your monthly payments will increase. If you are struggling now, taking out a second mortgage or refinancing may only make your situation worse. Even if you want to use your equity for a good purpose, it is not a good idea to borrow if you cannot afford to make the payments.

What are the benefits?
In general, the lower the risk to the lender, the less interest you will have to pay. A loan secured by home equity does not have as much risk as a loan without collateral, so the interest rate for home loans is usually lower than that for credit cards and personal loans. The repayment period is usually longer as well, which makes borrowing large sums of money more affordable. Also, in most cases, the interest that you pay on a loan secured by a primary residence is tax-deductible, unlike the interest paid on a credit card or personal loan. For example, if you had a marginal tax rate (the tax rate that is applied to the last dollar you earn) of 25%, paying $2,000 in interest on a home equity loan would save you $500 in taxes.

What are the alternatives?
If you need or want money, borrowing against your equity is not the only option. For example, you may be able to use credit cards or personal loans. The interest rates may be higher, but you do not put your home at risk. If you decide you can wait, you can save for your goals and avoid borrowing completely. Selling your house is another option. It allows you to access your equity without needing to worry about repayment.

The right to cancel
If you decide to borrow, but then regret it, you may be able to cancel if you act fast. The Truth in Lending Act, a federal law, gives you the right to cancel a loan secured by your home within three business days following the settlement, receipt of your disclosures, or receipt of your cancellation notice, whichever occurs last. You must notify the lender in writing, and you can only rescind if the loan is secured by your primary residence, not a vacation or second home. In addition, you are not given the right to cancel if you obtain the loan to buy or build your primary residence or you are refinancing your loan with the same lender who holds your existing mortgage and do not borrow additional funds.

Chances are, you worked hard to buy your home. Don’t make hasty decisions that can put it at risk. Read all paperwork thoroughly, and make sure you understand all of the terms before you sign anything. If you need to, get legal assistance. When done for the right reasons and under the right circumstances, using your home’s equity can be a wise financial decision.

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