A home equity loan is a loan you can access that’s based on your home’s equity, which is what you’ve already paid into your mortgage.
This type of loan can be used to finance a variety of things, including home repairs, renovations, and even debt consolidation.
If you’re considering taking out a home equity loan, it’s important to understand how they work and what their potential benefits and risks are.
What is a home equity loan and how does it work?
Homeowners can apply to access up to 80% of their home’s existing equity as a lump sum amount.
The loan, however, does use your home as collateral. This means that if you default on the loan, the lender could foreclose on your home.
But if you know that you’ll be able to afford its payments, it’s a good way to consolidate and pay off other high-interest debts. They can also be used for any large expenses, such as tuition, a wedding, or home repairs and renovations.
Home equity loans are available from both banks and credit unions. The interest rate on a home equity loan is typically lower than the interest rate on a personal loan or credit card.
When you take out a home equity loan, you borrow against the value of your home. The amount you can borrow is based on the equity you have in your home, which is the portion of your home that you own outright.
Home equity loan example
For example, if your home is worth $200,000 and you have a mortgage balance of $100,000, you have $100,000 in equity. This means you could potentially borrow $50,000 or more with a home equity loan.
The interest rate on a home equity loan is typically fixed, which means it will stay the same for the life of the loan. The repayment term is also usually fixed, which means you’ll make equal monthly payments for the duration of the loan.
One thing to keep in mind is that a home equity loan is a second mortgage, so you’ll repay this loan on top of your existing monthly mortgage payment.
The benefits of a home equity loan
There are several potential benefits of taking out a home equity loan, including:
- You can use the loan for a variety of purposes, including home repairs, renovations, and debt consolidation.
- The interest rate on a home equity loan is typically lower than the interest rate on a personal loan or credit card.
- Your home serves as collateral for the loan, which can give you a lower interest rate and may make it easier to qualify for a loan.
The risks of a home equity loan
There are also several potential risks to taking out a home equity loan, including:
- You could lose your home if you default on this loan and/or your original mortgage.
- The interest rate on a home equity loan is typically higher than the interest rate on your primary mortgage.
- You may have to pay closing costs when you take out the loan.
Using a home equity loan to pay off debt
A common use of home equity loans is debt consolidation.
When you consolidate your debt, especially debt with high interest, with a home equity loan, you take out a single loan to pay off multiple debts. You’ll then be able to avoid further interest charges and get out of debt sooner.
It’s important to carefully consider all of your options before consolidation and make sure you can afford the payments on the loan. Make sure to crunch all of the numbers thoroughly, since it’s your home that’s on the line if you fail to make your mortgage payments.
What else should I know about home equity loans?
- You’ll need to have enough equity in your home to qualify for a loan. The required amount may vary by lender but plan to have at least 20%.
- You’ll still need to qualify to be approved for the loan, so take note of any significant changes in your income or credit since you were approved for your original mortgage.
- You must be current on your mortgage payments to be considered for a home equity loan.
- The interest rate on a home equity loan is typically fixed.
- The repayment term is usually fixed, which means you’ll make equal monthly payments for the duration of the loan.
- A home equity loan is a second mortgage, which means you’ll repay it in addition to paying your monthly mortgage payment.
- You can use a home equity loan to consolidate your debt.
Use a home equity loan to improve your financial situation
Home equity loans can be a helpful way to access the cash you need for important scenarios, such as consolidating or paying off debts.
However, they also come with risks that you should be aware of before you take out a loan. Be sure to weigh the pros and cons carefully before deciding if a home equity loan is right for you.
Do the math and ensure that you’ll have enough to make your existing monthly mortgage payment, your home equity loan repayment, and your monthly debt payment, if applicable.
Paying off debt is a great way to improve your credit and relieve your monthly expenses.
Photo by Binyamin Mellish