When it comes to a home equity loan, you should remember that it is a form of consumer debt you will take through the refinancing process, which will provide you peace of mind. On the other hand, you can use it as the form of a second mortgage, which will allow you to borrow money against the equity of your home.

Therefore, the amount is a difference between the mortgage balance due and the home’s current market value. Generally, they feature fixed rates, while you will get a lump sum and repay in a matter of years, which is similar to a personal loan, but it features lower interest because it uses your home as collateral.

How Does It Work?

When it comes to a home equity loan, you should know that it functions in the same way as a regular mortgage, which is why we call it a second mortgage. However, the equity in the home will function as collateral. The amount you can borrow depends on the loan-to-value ratio of up to eighty percent of the home’s appraised value.

Remember that the amount and rate can change based on your payment history and credit score, altogether. Traditional home equity loans feature a set of repayment terms, which function similarly to a conventional loan. Therefore, you will make consistent, regular, and fixed payments that will cover both interest and principal.

At the same time, if you avoid paying off or reach a point of bankruptcy, then a lender will seize your home to satisfy the debt. A home equity loan is a perfect way to take advantage of the equity you have builtin the form of cash and return it through home renovation, which will further increase the value of your home.

Still, you should remember that you will put your household on a line, meaning if the real estate value decreases, you will end up owing more than the actual home’s worth, which is known as negative equity.

Besides, getting a home equity loan, while planning a move in the next few years is the worst course of action. The main reason for that is because you will lose money on the sale of a home. If you use the lump sum for repaying the credit card debt, the chances are high that you will not be able to resist the temptation to max out your card again.

You should weigh all options before putting your home on the line. If you wish to get a significant amount, it is vital to compare various rates and different lending options. For instance, cash-out refinance may be the better option, because through it you can tap the equity by replacing the old mortgage with a new one instead of doubling it.

Things to Consider

You should know that home equity loans became widely recognized and popular after the Tax Reform of 1986 because they allowed people to eliminate deductions for interest on numerous purchases.

However, in 2017, the new act suspended the deduction for home equity loans and lines of credit unless you decide to improve, build, or renovate a household you used as collateral. It means that the amount is not tax deductible if you use the money you get for college expenses or to pay off credit cards.

Similarly, as with mortgages, you can ask for a good faith estimate, but you should honestly assess your finances beforehand. It means you should understand the credit score and overall home value before making up your mind, which will help you save money.

For instance, home equity loans come with annual percentage rates that include closing costs, and appraisal, which are significant expenses. Therefore, if it is too low to handle the loan, it means you should avoid doing it. You should think about it before applying, which will save you both money and time.

Before signing, especially if your goal is to use home equity loans for consolidating debt, you should determine whether you will get lower monthly expenses than combining the debt altogether. Although home equity loans feature low-interest rates, the term is longer, meaning you will end up paying higher interest throughout the loan’s life.

Home Equity Loans vs. Lines of Credit or HELOC

Home equity loans are similar to personal, meaning you will get a lump-sum amount you agreed on beforehand, which you will repay at a fixed interest rate for any particular period that goes between five and fifteen years. The payment and interest will remain the same throughout the years, meaning you must repay everything to ensure you become the sole owner of the property.

On the other hand, an equity line of credit or HELOC is a revolving loan that functions similarly to a credit card. It means you will get a specific amount you can draw when required, repay, and use it again. The draw period lasts between five and ten years, meaning you can take the money out of the account and repay it throughout these moments.

However, after the draw period, you will enter the repayment period, when you cannot draw anymore, while you must repay the overall balance in the next ten to twenty years. HELOCs come with adjustable interest rates, while you can visit some lenders that will offer you fixed ones instead.

Benefits of Home Equity Loans

As you can see, getting a home equity loan is a perfect way to get a lump sum of cash with a low-interest rate, which is a perfect solution for responsible and stable borrowers.

In case you have a reliable and steady source of income and know what you wish to do and how to repay the loan, then the possible tax deductions and low interest will make it a better alternative to a personal loan.

At the same time, it is straightforward to get it especially because you will apply for a secured debt. The lender will check out your credit score and conduct a home appraisal to determine the CLTV and creditworthiness.

When it comes to interest rates, you can rest assured, because it is lower than a personal loan or credit card. Of course, it features collateral in the form of your household, meaning you should determine whether it is worthwhile to borrow against the value of your household, or choose an unsecured debt with higher interest rates but without the risk of losing your house.

Generally, they are perfect if you are a responsible individual who exactly knows what to do with the amount and how to improve the overall lifestyle. Since you will get a guaranteed amount, you will receive complete efficiency.

Therefore, home equity loans are perfect for handling expensive and significant goals such as paying for higher education, home remodeling, and reroofing, and in some situations, you can use a portion to consolidate high-interest debts from credit cards or payday loans. Still, you should be aware of the consequences beforehand, which will help you decide.

Final Word

You probably understand that entering a debt is not for everyone, because you may enter a cycle of borrowing and spending. This is a common scenario with a specific term, which is reloading, meaning you have a spending habit of repaying the existing debt with a new one and so on.

The cycle of debt may lead to severe financial strain, lower credit scores, and inability to deal with daily expenses. We recommend you to think twice and weigh all options before choosing to use your home as collateral. It is as simple as that.