Home Equity Loans

Home equity loans allow you to cash out some of the equity that you’ve accumulated in your home. In essence, a home equity loan is like a second mortgage, in which you take out a loan and use your property as collateral. There are a number of reasons why a home equity loan is advantageous as well as some issues you should consider before getting a home equity loan.

What is a home equity loan?

A home equity loan is a type of secured loan where the equity in your home is used as collateral. Your home equity is the value of your home versus how much you still owe on your mortgage. For example, if you have a $100,000 mortgage and your home is worth $125,000, you would have about $25,000 in home equity. Home equity can be accrued by paying down your mortgage, improving your home to increase its value or by appreciating your home’s value over time.

A home equity loan is essentially treated as a second mortgage. That is, your original mortgage stays in place and has primacy over your home equity loan. If you default or foreclose, the holder of the original mortgage gets paid first and the lender of the home equity loan gets paid second. Meanwhile, you still have to make payments and pay interest on both your mortgage and your home equity loan.

Home Equity Loan Advantages

The main advantage of a home equity loan is the relatively low interest rate you can receive. Unlike credit cards, which are unsecured loans, home equity loans use your property as collateral. This reduces the risk for the lender and nets you better terms on your loan. A home equity loan is perhaps the most affordable loan you can receive, next to the mortgage itself. Home equity loan interest rates are typically determined based on the prime rate plus a margin. While your credit score is factored in to a degree, it does not affect your loan terms nearly as much as a unsecured loan or credit card would.

The other alternative to a home equity loan is mortgage refinancing. Compared to refinancing, home equity loans are much easier to obtain and are better for short to mid term loans.

Why Get a Home Equity Loan?

Home equity loans open the doors to many opportunities by offering you low-cost financing for practically anything you can imagine. Home equity loans will usually give you a lump sum cash disbursement, meaning you can easily and immediately have an extra $25,000, $50,000, $100,000 or more chunk of cash in your pocket.

Of course, while the interest rate is low, this isn’t free money. As such, it’s best to use a home equity loan for an investment that will pay back the costs of the loan. Most homeowners use a home equity loan for:

• Home Improvements. Building an addition, finishing a basement or doing any other kind of work for your home that will raise its value is a common and prudent use of a home equity loan. In addition to raising the market value of your home (which will have monetary rewards when you sell), you will also increase the equity in your home once you complete the improvements and repay your loan.
• Paying for Education. The investment value of paying for tuition is obvious. Home equity loans often have lower rates than private student loans and personal loans.
• Debt consolidation. If you have multiple outstanding debts, you can save significantly and simplify your life by consolidating your debt into a single home equity loan. For example, if you have $10,000 in credit card debt at 19.99 percent, $5,000 in auto loans at 7.25 percent and $40,000 in student loans at 8.5 percent, you can take out a $55,000 home equity loan at an interest rate of 7.00 percent and pay them all off. Now, you’ll have just one monthly payment to make at a significantly lower interest rate.
• Emergencies. For unexpected medical bills, accidents or other costs, a home equity loan may be a better choice than racking up credit card debt or getting a personal loan. While not an investment per se, home equity loans for emergencies make financial sense because of their lower interest rates.

Home Equity Line of Credit

Another form of loan that uses your property as collateral is a home equity line of credit (HELOC). Whereas a home equity loan gives you money in a lump sum and has you pay it back in monthly installments, a HELOC works like a credit card. The interest rates are lower than credit cards and home equity loans and offer greater flexibility. Home equity lines of credit are revolving accounts where you pay an annual fee and can borrow a variable amount of money and pay off some or all of the balance at the end of the month. For example, if you have $25,000 in home equity, your home equity line of credit would allow you to borrow up to $25,000. However, if you only borrowed $10,000, you would only pay interest on that amount for each month you carried a balance. This allows you to pay less in interest than you would if you got a lump sum of $25,000 and paid it off over five years.

Conclusion

Home equity loans and home equity lines of credit are convenient, affordable and flexible financing options that allow you to use your home as collateral to land low interest rates. Like all loan instruments, home equity loans provide measured amounts of opportunity and liability. Borrow against your home equity wisely to avoid putting yourself further into debt. For more tips on home equity loans and home equity lines of credit, read some of our relevant blog topics below: