What is a Home Equity Loan?
A home equity loan allows you to borrow against the value of your home by using it as collateral. You’ll receive a lump sum and repay the loan with fixed interest over a set term. This type of loan is ideal for homeowners looking to access their home’s equity without selling the property. As you continue making mortgage payments and your home’s value appreciates, your equity grows, which you can then tap into through a home equity loan. It’s a popular choice for those looking to finance home improvements or other significant expenses.
What Is a Home Equity Loan?
A home equity loan lets you convert a portion of your home’s equity into cash. The loan is given as a lump sum, which you repay at a fixed interest rate over a term ranging from 5 to 30 years. Typically, you can borrow 80% to 85% of your home’s value, minus the amount you owe on your mortgage. Some lenders may allow you to borrow even more, up to 100% of the home’s value in certain cases.
For example, if your home is valued at $350,000, and you owe $200,000 on your mortgage, you might qualify to borrow up to 85% of the home’s value. This would give you $297,500 in total available equity, and after subtracting your mortgage balance, you could borrow $97,500.
How Does a Home Equity Loan Work?
Also known as a second mortgage, a home equity loan uses your property as collateral. You receive the loan amount in full at closing, and you repay it over time with fixed monthly payments that include both principal and interest. This repayment does not affect your existing mortgage, which remains separate. However, it’s important to ensure you can comfortably manage both your primary mortgage and the additional home equity loan payment.
Because the loan is secured by your home, it typically offers better interest rates than unsecured loans. However, defaulting on payments could put you at risk of foreclosure, so it’s essential to carefully consider your financial situation before taking out this type of loan.
How to Use a Home Equity Loan
While you can technically use a home equity loan for any expense, it’s generally recommended to use it for purposes that build wealth, such as home renovations or consolidating high-interest debt. Improvements that increase your home’s value are particularly smart, as they can generate a return on your investment. In some cases, the interest you pay on a home equity loan can also be tax-deductible, especially if the loan is used for home improvements.
Home Equity Loans vs. HELOCs
A home equity line of credit (HELOC) differs from a home equity loan in that it provides access to a revolving line of credit instead of a lump sum. You can borrow and repay funds as needed, similar to a credit card. HELOCs typically have variable interest rates, which can result in fluctuating monthly payments.
Home Equity Loans vs. Cash-Out Refinances
A cash-out refinance involves replacing your existing mortgage with a new, larger loan, allowing you to take out the difference in cash. This option resets your mortgage with new terms and interest rates, which could be a disadvantage if rates have increased since you initially financed your home.
Additionally, cash-out refinances come with closing costs, which can add to the overall expense.
A home equity loan is a practical way to access the value you’ve built in your home, providing a fixed-rate solution for large expenses like renovations or debt consolidation. However, it’s crucial to use your home’s equity wisely and ensure you’re financially prepared to manage both your primary mortgage and the new loan.