Home Equity Loans Are Still a Smart Financing Option Even with New Tax Laws
New IRS tax laws for 2018 confused even the most seasoned CPAs, but the IRS has issued some clarification about the deductibility of interest on Home Equity Loans. For borrowers planning to use a Home Equity Loan to finance home projects like replacement windows, a new roof, or building an addition/remodel, the news is good. That interest is still deductible as long as the total home mortgage interest falls below the new 2018 limit (covered later in this article). Unfortunately, for folks planning to use the equity in their home to pay off credit cards, pay for college, or take a vacation, that interest is no longer deductible.
Some might ask, does it still make sense to use a Home Equity Loan to pay for expenses now that the interest deduction is gone? Kevin Peterson, Empower Federal Credit Union’s Vice President of Consumer Lending says, “Yes,” and here’s why:
Even without the Deduction, Home Equity Remains One of the Cheapest Ways to Borrow Money: “Because Home Equity Loans are secured by real estate, interest rates are much lower than unsecured personal loans or credit cards. Interest rates on Home Equity Loans can usually range between 3% and 5%, depending on your lender and certain underwriting criteria. Personal loan interest rates typically start above 8%, and can go much higher. Credit cards average just under 15%,” explains Peterson.
Your Interest Rate is Fixed: Most people have a variable APR on their credit cards, meaning the interest rate on the card is tied to interest rates in general. Most credit card companies link APRs to the prime rate, which is the rate banks charge their biggest, best customers for loans. So, if the prime rate goes up, so does your interest rate. On a Fixed (or Closed-End) Home Equity Loan, your interest rate is locked for the term of the loan, usually between 60 and 180 months, meaning there are no surprises.
Consolidating Your Debt Can Save You Money: Say you have $40,000 in combined credit card debt at interest rates ranging from 9.99% up to 15%. Even though you make the minimum payment on your cards every month, you’re still incurring interest expense. If you were to take out a Home Equity Loan for $40,000 to pay off your credit card debt, your interest rate on the Home Equity Loan would be much lower. You’re still paying interest on this debt, but at a much lower rate. The bottom line is you still own the debt, but your carrying costs decrease.
You Can Boost Your Credit Score: Paying down credit card debt will help your credit rating. “Wiping the slate clean is always a good idea,” confirms Peterson. “It will have an immediate impact on your credit score and improve your debt ratio, making you more attractive to lenders in the future. This can help you to secure better rates on other loans going forward.”
You Can Pay Off Debt Faster: Lower interest rates means more of your monthly payment goes toward paying down principal on your loan, so your debt gets repaid faster.
You Have Access to Greater Loan Amounts for College: Interest rates on Home Equity Loans can sometimes be lower than those on student loans depending on what’s available, and the U.S. Department of Education does impose annual loan limits on federal loans. These loan caps may not provide families with sufficient borrowing power, especially if the student is attending a high-cost college or university. Home Equity Loans can be beneficial when higher funding amounts are needed, providing homeowners have sufficient equity.
Home Equity Provides a Tax-Deductible Source for Home Improvement Funding: As long as the proceeds from your Home Equity Loan are used “to buy, build or substantially improve the taxpayer’s home that secures the loan," then the interest is deductible, within limits. The new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of new qualified residence loans ($375,000 for a married taxpayer filing separately). The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.
You Control the Term: Using equity in your home to finance projects, education, or consolidate debt also provides the borrower with greater flexibility in terms of loan term. Student loans typically have a specified repayment period of 10 years. Using a Home Equity Loan allows the borrower to stretch out the payment through extended terms, sometimes up to 180 months.
Be Sure You Have Adequate Insurance: Lastly, Peterson recommends homeowners who are interested in taking out a Home Equity Loan as a financing solution get their homeowner’s insurance in order. To finance a Home Equity Loan, you need to have adequate insurance coverage. This is a great time to talk to your Insurance Agent to ensure you have proper coverage and possibly even save money on your annual premium.
Empower Federal Credit Union does not provide tax or legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on, for tax or legal advice. You should consult with your own tax and/or legal advisors on the deductibility of all home loan interest.
What’s Stopping You from Buying a Home or Refinancing Your Mortgage?
“I don’t have enough saved for a down payment or closing costs.”
A recent Zillow-sponsored online survey of 10,000 renters ages 18 to 75 nationwide found that 67.9 percent of participants believe their inability to save for a down payment was their biggest barrier to homeownership. This was heard from market to market, regardless of geography or average home cost.
“There is a common misconception among would-be home buyers that twenty percent down is the only financing option available to them,” says Bob Padula, Empower Federal Credit Union’s Vice President of Mortgage Lending. “The reality is that as home prices continue to adjust back to their pre-recession levels, fewer and fewer home buyers will have that 20 percent sitting in the bank. But there are several loan products available to first-time home buyers that don’t require 20 percent down.”
A HomeReady™ mortgage is one such product. With down payments as low as 3 percent and competitive interest rates, a HomeReady™ mortgage is an ideal solution for someone with limited funds for a down payment and/or who needs to use income from a household member not listed on the loan, or someone who needs to have a co-signer.
Padula also suggests buyers research programs like the First Home ClubSM which allow first-time home buyers to earn up to $7,500 toward the purchase of their first home by opening a dedicated savings account and making monthly deposits into that account. Through this and similar first-time home buyer programs, you may be able to purchase a home with as little as 3 percent down and use grants and gifts from family members toward closing costs.
Seller concessions are another way to help offset the burden of closing costs. Your realtor can advise you as to what is realistic and appropriate for your local real estate market.
“My credit is not great. I probably will not qualify.”
In the same Zillow survey, 53.2 percent of respondents attributed their home buying difficulty to the ability to qualify for a mortgage. And 50 percent said debt from credit cards and other loans was their most significant hurdle.
“To qualify for a mortgage, your credit score can be as low as 620. And, if you have 20 percent equity in the property, there is no minimum credit score requirement,” advises Padula.
Leading up to the purchase, potential home buyers should do everything in their power to boost their credit scores. Be sure to double-check your credit reports to ensure you’re not being unfairly penalized for old, paid or settled debts. It’s also best to stop applying for new credit a year or so before you apply for a mortgage and until after you close on your home.
If you’ve accrued substantial debt, Padula recommends looking into debt consolidation with an unsecured personal loan and starting to pay down what you owe at the lowest possible interest rate. Consolidating credit card debt from multiple sources into one loan can immediately improve your credit score.
“Renting is cheaper than buying.”
Many believe that monthly mortgage payments will far exceed what they are currently paying in rent. With the exception of a handful of mostly west coast markets, this is usually not the case. Although the savings of buying versus renting vary from market to market and change as interest rates change and rents fluctuate, on average, buying a home is currently 33.1 percent cheaper than renting .
“I can’t afford to maintain a home.”
Recognizing that there are costs associated with home ownership that go above and beyond the down payment and monthly mortgage bill is important and being financially prudent. When you’re house hunting, look to buy a home that has been well-maintained and/or recently had major components upgraded or replaced, such as a new roof, new HVAC, new water heater, plumbing or electrical upgrade. Sometimes it pays to buy a newer home, but not always.
Regular home maintenance can prevent small problems from becoming major (and costly) repairs. Maintaining an “emergency fund” and adding to that fund every month ensures you have the necessary cash on hand to pay for a repair or replacement that takes you by surprise. A thorough home inspection prior to purchase can give you a better idea of the condition of the home you’re considering and the types of repairs you may be faced with if you become its owner.
“I’m not sure if it makes sense for me to refinance, and I don’t even know where to begin.”
If you’re like many homebuyers, your realtor held your hand through the process of buying your first home and qualifying for your first mortgage. Now that you’re considering refinancing, you just don’t know where to begin.
A good mortgage lender will be able to address all of your concerns and some you weren’t even thinking about. He or she can help you with the financial analysis and help you determine which mortgage product and term will work best for you and your income level. Just like with first-time home buyers, there are refinancing options that can reduce your out-of-pocket costs at closing and your monthly payments going forward.
Mortgage Rates Still Low Enough to Put Money Back in Your Pocket
While low interest rates may not be helping to grow your savings account or share certificates, they can help your pocket book in a very real way if you’re looking to purchase a home or refinance an existing mortgage
. Despite recent rate hikes by the Federal Reserve, interest rates on home mortgages continue to be at historically low levels, offering homeowners and prospective homebuyers some significant advantages.
“For those homeowners who think they missed out on the ‘refinance boom’, this could still be a great time to refinance,” advises Robert Padula, Empower Federal Credit Union’s Vice President of Mortgage Lending. “Even though rates have increased since December, they're still at multi-decade lows. If you look at the 30-year fixed mortgage rate over the past 10 years, it peaked around 6.76%. Right now, rates are just above 4.0%, and if you’re looking to pay off your mortgage faster, 10 and 15-year fixed rate terms are in the high 2% to low 3% range. Rates have risen, but they're still historically low.”
Reduce Your Monthly Payment:
If you currently own a home and have good credit, consider refinancing your existing mortgage to lower your interest rate and your monthly payment. Lowering the interest rate on your mortgage allows a bigger chunk of your monthly payment to go toward paying down principal instead of interest, if you continue to make the same monthly payment. Or, you can use your monthly savings to make home improvements or pay down other higher interest debt like credit cards.
Increase Your Purchasing Power:
Simply put, purchasing power is the amount of home you can afford to buy for the budget you have available to spend. The interest rate on your mortgage impacts not only your monthly housing costs, but also your overall purchasing power. If you’re buying your first home, or are considering buying a second-home or investment property, lower interest rates can help to increase your purchasing power by allowing you to buy a slightly more expensive home and still stay within budget. As interest rates increase, the price of the house you can afford will decrease if you plan to stay within that same monthly housing budget.
Tap into Home Equity:
Now is also a good time to borrow money at inexpensive rates. Homeowners can elect to take out a Home Equity Loan
by borrowing against the value of their home. In doing so, homeowners receive funds in a lump sum so they can undertake home remodeling projects or finance an education or vacation. However, if you take money out of your home, it is always a good idea to use that money wisely. One of the smartest decisions is to pay off higher interest rate debts, like credit cards, to lower your overall monthly payments. This allows you to free up cash each month and to start saving for the future.
Many experts predict that mortgage rates will continue to rise and could be closer to 5% by this time next year. If you’ve been putting off refinancing or buying a home, now is the time to pull the trigger. Padula advises homeowners to shop around and compare interest rates
, closing costs, and other features to find the combination that works best for them.
8 Things Every First-Time Home Buyer Should Do:
It’s the American Dream. Picket fences. Window boxes. Shade trees and a lawn to mow at your own Home Sweet Home. Even if that isn’t your dream house, owning a home, whether it’s an apartment, duplex, townhouse, ranch or quaint Cape Cod is often a top priority among many Americans. Thanks to record low interest rates over the past several years, many first-time home buyers have been able to make their dreams come true. By thinking ahead and doing a little planning, owning your own home is possible. Here are some helpful tips:
1: Start saving for a down payment before you think you’re ready to buy a home or even start looking. Put away a little from each paycheck into a separate account each month. You’ll be surprised how quickly it adds up.
2: Look into first time home buyer programs in your area. “Many banks and credit unions have specific programs for first time home buyers,” suggests Empower Federal Credit Union’s Vice President of Mortgage Lending Bob Padula. “Some of them require you to open an account and save a minimum amount per month for a specific period of time. In return, you’re offered a first-time home buyer grant to put toward your first home. This can often be several thousand dollars. That combined with your own savings is a great start on a down payment or to put toward closing costs.”
3: Don’t commit before you’re ready financially or otherwise. Owning a home is a huge commitment and more expensive than many home buyers realize. Be sure you are ready for the financial commitment that comes with a mortgage and the responsibility of maintaining your home and investment.
4: Think ahead. The house you need today won’t likely be exactly what you need in 3-5 years. It’s smart to plan for the future so that you’ll outgrow your home a little slower. If you think you might have children or need a yard for a pet, those are good things to keep in mind. The average first-time home buyer only owns his/her first home for an average of 4-10 years. But planning for your future today can save you money in the long run.
5: Set priorities in advance about location, size, number of rooms, school district, etc. If you know in advance what trade-offs you’re willing to make, you’re better able to make well thought out decisions during the home buying process and avoid the disconcerting feeling of buyer’s remorse.
6: Secure financing and understand your budget before falling in love with a property. Buying a home should not be a decision you make based on emotion. It’s best not to find your dream house and fall in love with it before you understand if it’s even within your budget. “Generally speaking, most prospective homeowners can afford to mortgage a property that costs between 2 and 2.5 times their gross income,” advises Padula. It’s usually a good idea to fill out a home mortgage worksheet or use an online affordability calculator so you have a rough idea of what you can afford. Then meet with a mortgage lender to fill out the necessary paperwork so you are pre-approved for a certain loan amount before you even start going to open houses.
7: Understand all of the financial costs associated with home ownership. Depending on your down payment, these can include paying Private Mortgage Insurance (PMI), homeowner’s insurance, property/school taxes, and home owner’s association (HOA) fees on top of your monthly mortgage payment. It’s also smart to have an idea of the age and replacement costs of various components of your home, particularly things that are rather costly to replace such as the roof, HVAC and water heater. If you’re likely to be replacing one of these within the first few years of ownership, that’s an additional expense you’ll need to plan for sooner rather than later.
8: Don’t spend every dollar you qualify for. It is usually the smartest decision to be fiscally conservative and set an upward spending limit that is less than the total mortgage for which you’ve been approved. This can open up additional options such as buying a less expensive home and remodeling or qualifying for different lending programs with lower rates that save you money in the long term.