Home Equity Loans

Let us take a minute and understand tax deductions for second mortgage and home equity loan interest. Among the most attractive features of second mortgages is the federal tax-deductibility feature of their interest payments, which reduces the effective cost of the loans to borrowers. However, before signing those loan papers, it’s important to understand just what you can and cannot deduct off your taxes.

To qualify for mortgage interest tax deductions, your mortgage must be secured by your first or second home. Loans secured by subsequent homes (e.g., third or fourth homes) do not qualify. A home, according to the Internal Revenue Service (IRS), must be a house, condominium, cooperative, mobile home, boat, recreational vehicle or similar property that has sleeping, cooking and toilet facilities.

IRS Publication 936 states that all of your mortgages must fit into one or more of the following three categories at all times during the year.

1. Mortgages taken out on or before October 13, 1987 (grandfathered debt).

2. Mortgages taken out after October 13, 1987, to buy, build, or improve your home (home acquisition debt), but only if throughout the current tax year these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).

3. Mortgages taken out after October 13, 1987, other than to buy, build, or improve your home (home equity debt), but only if throughout the current tax year these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

Types of Mortgage Debts

A grandfathered debt is fully deductible with no limits.

A home acquisition debt, also known as acquisition indebtedness, is money you borrow to buy, build or substantially improve your qualified residence (an IRS term for your first or second home). A home equity debt, also known as equity indebtedness, is money you borrow against the equity in your qualified residence or money you cash out on a mortgage refinance for any reason other than home improvement. To deduct the mortgage interest, you will need to file a Form 1040 (the long form with itemized deductions, not 1040 EZ). Your lender will send you a Form 1098 listing the mortgage interest you paid during the tax year. Check with a licensed tax professional for other conditions and limits that may apply.

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Your home is an investment. And like any investment, it is worth money. More specifically, your home has equity. Second mortgage home equity loans can open the financial door for you to cash in on the money that you have accrued so far. You can then take this money and use it for a number of well deserved things. You can pay off some of your debts and get your credit back on track. If you are already struggling with finances, this is your best option as it can get many creditors off your back and off your telephone.

You are also free to use this money on a long awaited family vacation. Use the second mortgage home equity loan to do some home improvements and further enhance the value of your investment. The bottom line is that getting a second mortgage home equity loan can widen the financial gap between a tight budget and a lenient one.

If this is your first time looking into home equity, then you might be asking yourself “What is equity?”. Equity is basically a portion of ownership. You see, when you first get your home you got a mortgage loan from a lender. This lender owns the home because you used their money to pay for it. However, as the months and years go on, you make payments on your mortgage loan. Each payment raises how much you have invested into the value of your home. The market value also rises as the years go on, and each year you own more of your home. As you own more, the lender owns less.

Now take a look at your current mortgage. How much money is left to be paid? That number is the equity. What we are talking about is taking out a second mortgage home equity loan and taking full advantage of the value that you have built up over the years.

Now when you take out a second mortgage home equity loan, the money that results from this is yours. That is right, the money is yours. So you can go ahead and do with it as you please, but there are a few common things people use this money for. Doing types of home improvements is the biggest common use. Now you have the money to do those expensive ideas or repairs that you have been wanting to do for quite some time now. Repair that roof so next winter is not as bad. By doing this you are adding to the value of your home. And what happens when you increase the value of your home? You raise the equity in your home.

As mentioned earlier, you might want to take that money and get rid of your debts. Or better yet, consolidate your debts to decrease your monthly payments, and then set a portion of that equity money aside to pay for a few months of these new, less expensive payments. Then you can use the remaining amount to pay for whatever else you want.

And lastly, the family vacation. These days it is pretty expensive to take the whole family out on a real vacation. Take the kids to Disney, or go for a week long camping trip. Fly out to Las Vegas and get pampered in the hotels and have fun with a night on the town.

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If you have bad credit, but want to save some money and repair your credit score, take out a home equity loan. Of course you need to own a home first, but if you already own a home, and are serious about raising credit score and saving money, then a 2nd mortgage is a great start. Home equity loans will enable you to pay off collections, bad debts, judgements, and past due credit cards. Even if you had a bankruptcy years ago, home equity loans can offer solutions to many high interest debt problems. Second mortgages have become somewhat easier for homeowners to qualify for with credit issues, such as, low credit scores, late payments, or collection accounts.

The down-side is that you won’t be offered prime interest rates from any second mortgage lender if you have low credit scores and past late payments reported with your mortgage loans. Is paying a higher rate the end of the world? Of course not… It is a temporary finance solution to get you back on track.

The bottom line you need to focus on is whether or not the home equity loan offers you monthly savings by consolidating your debt. If you save a few hundred dollars a month and eliminate revolving credit cards, then who cares what about the interest rate. Besides, as soon as your credit score increases to a 680 fico, you can refinance the sub-prime equity loan for a reduced rate second mortgage and save even more a month. Remember, “Rome wasn’t built in a day.” With debt consolidation, it’s not all or nothing. If you can save money now with a bad credit home equity loan, then take advantage of the monthly savings.

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