Home Equity Loans 101
Do you have equity built into your home? Borrowing against it with a home equity loan is a great way to tap into the money you need when you need it most. Many people take out a home equity loan to finance home improvements, pay for their child’s college education, cover unforeseen medical costs, and many other purposes. Here’s all you need to know about home equity loans.
What is a home equity loan?
A home equity loan (HEL), or second mortgage, is a secured loan that allows homeowners to borrow against the equity in their home. The loan amount is based on the difference between the home’s current market value and the homeowner’s outstanding mortgage balance. Home equity loans tend to be fixed-rate, while the typical alternative, home equity lines of credit (HELOCs), generally have variable rates and allow the borrower to withdraw funds as needed.
How is a home equity loan amount determined?
Your primary mortgage is the amount you borrowed when you borrowed when you first purchased your home. Over time, as you pay down the loan and/or the value of your residence increases, so does your equity. You can take a home equity loan out against the equity you have built up in your home, essentially borrowing against your home’s value minus what you still owe on your mortgage. It’s important to note that a home equity loan is a second loan against your home. You’ll still need to pay your primary mortgage along with new payments for your home equity loan.
Home equity loans typically have a fixed interest rate, making budgeting for the payments easy. The lender provides a lump sum payment to the borrower, which is then repaid over the life of the loan, along with a set interest rate. Both the monthly payment and interest rate will remain the same over the entire loan term, which can last anywhere from 5 to 30 years. If the borrower sells the home before the loan term is matured, the loan must then be repaid in full.
A home equity loan can be a great choice for a borrower with a one-time or straightforward cash need such as a home addition, large medical expenses, debt consolidation, or a wedding.
Pros and Cons
There are many advantages to taking out a home equity loan to fund a home improvement project or large expense.
- The amount of interest paid toward a HEL may be tax-deductible
- Interest rates on HELs are generally lower than those provided by credit cards or unsecured loans.
- Using your home as collateral for the loan means risking foreclosure and the loss of your home if you default on the loan
- If your home value declines over the term of the loan, you may end up owing more than your home is worth
- You’ll need to pay closing costs and other fees when you take out a home equity loan
- You may qualify to borrow more than you actually need and ultimately end up using more than planned, which of course you’ll need to repay.
The hot real estate market has led to a boom in popularity for home equity loans. However, it’s important to weigh all factors carefully before determining if a home equity loan is best for your specific needs.