A home equity loan is like a second mortgage, secured by your equity in your home. The amount is based on the market value of the home, less what you owe on your first mortgage or other loans on the home.
You can use a loan secured by your home to provide money for investments or for your business, to pay college expenses, or to cover renovations to the property.
The risk of home equity loans is putting up your home as security. You can lose your home if you don't keep up with the loan payments even if you continue to pay a first mortgage.
That's the reason it's rarely a good idea to use a home equity loan to pay for non-essential expenses.
REFINANCING YOUR MORTGAGE
If you refinance your mortgage, you take a new loan and use some or all of the amount you borrow to pay off what you owe. You might consider refinancing if the interest rates on new loans are less than the rate you are currently paying. One rule of thumb is that it pays to refinance if the new rate is at least two percentage points lower than your current rate. But you may benefit even if the difference is smaller.
Before you refinance, you'll want to add the expense of making the change — including a new title search and title insurance, attorney's fees, credit checks, and other costs. Then you divide that total by the amount you'll save on each new mortgage payment. The answer tells you how many months you'll have to live in your home before you break even and begin to save money.
You might also consider changing the term of your mortgage when you refinance. If you can afford to pay off your loan in 15 years rather than 30, for example, you can save a substantial amount of money. The rate on a shorter loan is often lower, but the monthly payments are higher.
Any gain above those amounts is taxed at your long-term capital gains rate if you've owned the property for more than a year. However, if you sell at a loss, it is considered a personal, not a capital loss. That means you can't use the loss to reduce taxes you may owe on other capital gains or on regular income.
Your cost basis includes not only the purchase price but amounts you spent over the years to make improvements, plus the costs of selling the home. That's one reason why it's important to keep good records while you own the property. Routine maintenance expenses, like mowing the lawn or painting the kitchen, don't count toward increasing your basis, but many other costs do. Remember, though, that your basis can also be decreased if you've received certain subsidies or credits, got an insurance payment to cover losses, or took a depreciation for using part of your home as an office. Check IRS Publication 17 and talk to your tax adviser.
One complication may occur if you sold a home before 1997 and rolled any profit from the sale into your current home. You should read chapter 3 in Publication 523 and talk to your tax adviser.
And there may be exceptions to the requirement that you live in your home for at least two of the five years before you sell. If you're disabled, in military service, or have some other good reason for selling, it pays to check.