HOME REPAIRS AND HOME EQUITY
Regina Conrad and her son Alex wrote to THAT MONEY SHOW with a tough question: should they use the $12,000 Regina has saved over the last two and a half years in a savings account for Alex's college tuition, or on immediate and necessary home repairs?
Regina, a research assistant at an electronics company, earns about $60,000 a year, and her monthly expenses range from $2,100 to $2,500. She has owned her home in Ossining, NY (near New York City) for three years, and has investment money in a mutual fund that has been performing very well over the past five years.
For some sound advice on how to handle her situation, THAT MONEY SHOW hooked Regina up with Marlene Cintron of Merrill Lynch. After an analysis, Marlene came up with the following plan for Regina and Alex:
1. Don't cash in any part of the mutual fund. It's growing very well (at about 20% each year) and should be guarded for long-term uses. Also, the profits from the mutual fund would be subject to capital gains tax after the sale -- and nobody wants to pay more taxes than necessary.
2. The house needs a new boiler and a new sidewalk. These are really pressing repairs, and the money that has been saved for Alex should be used to make these repairs as soon as possible. Marlene cautions, however, that in the future, Regina should keep three month's expenses in an emergency fund.
3. By the time Alex is ready for college, Regina will have been paying off her mortgage for about six years and will have accumulated a solid amount of equity in the home. A home equity loan could be a very good way to finance a portion of the college expenses. The interest on such a loan, as with mortgages, is tax deductible, and could save Regina some money in the long run.
If you don't know much about home equity loans (second mortgages), or home equity lines of credit (HELOC), here's some information you might find useful. But first, remember to shop around before considering any kind of a loan. Different lenders offer many rates and repayment terms. Look for one that could work to your advantage.
HOME EQUITY LOANS
Typically called a "second mortgage" or "term equity loan," a home equity loan allows homeowners to borrow against the equity (value minus outstanding loans) or their homes. For instance, if a home is worth $100,000, but the outstanding mortgage is about $40,000, the homeowner may be said to have $60,000 equity in her home against which she can borrow.
The loan, like a mortgage, is for a fixed term (usually 10 to 20 years) at a fixed interest rate. Upon approval, the lender will hand over a check, and the borrower must start paying interest from that moment. The interest on this type of loan is usually tax-deductible, making this kind of loan more attractive than other kinds of loans. However, the IRS rules that govern interest deductions are complicated, and you should check with a financial advisor to be sure your home qualifies. And, be careful: interest rates on home equity loans may be higher than those for traditional mortgages. This added expense should be considered when thinking of a home equity loan.
HOME EQUITY LINES OF CREDIT
"HELOC" for short, this line of credit usually gives you a checkbook or a credit card to access your money. Like a credit card, it doesn't have a fixed term (as long as you own your home), and you don't start paying interest until you actually use the money. Moreover, you only pay interest on the amount you've spent rather than on the total value of the line of credit.
This can be quite beneficial if you're using the line of credit to finance a long-term project. You don't take all the money at once, as you would with a traditional loan, and you don't have to worry about paying back what you haven't spent. Unfortunately, since you access your line of credit using a credit card or checkbook, there can be a lot of temptation to spend it on everyday items, as you might with plastic. So be cautious: this is your home on the line. If you go crazy spending and then can't make the payments, you may be jeopardizing your house.
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