What Is a Home Equity Loan?

A home equity loan—also known as an equity loan, home equity installment loan, or 澳洲幸运5官方开奖结果体彩网:second mortgage—is a type of consumer debt. Home equity loans allow homeowners to borrow against the equity in their homes. The loan amount is based on the difference between the home’s current market value and the 澳洲幸运5官方开奖结果体彩网:homeowner’s mortgage balance due. Home equity loans tend to be fixed-rate, while the typical alternative, 澳洲幸运5官方开奖结果🌌体彩网:home equity lines of credit (HELOCs), generally have variable rates.

How a Home Equity Loan Works

Essentially, a home equity loan is akin to a mortgage, hence the name second mortgage. The 澳洲幸运5官方开奖结果体彩网:equity in the home serves as 澳洲幸运5官方开奖结果体彩网:collateral for the lender. The amount that a homeowner is allowed to borrow will be based partially on a 澳洲幸运5官方开奖结果体彩网:combined loan𓆏-to-value (CLTV) ratio of 80% to 90% of the home’s 澳洲幸运5官方开奖结果体彩网:appraised value. Of course, the amount of the loan and the rate of interest charged also depend on the borrower’s 澳洲幸运5官方开奖结果体彩网:credit score and payment history.

Traditional home equity loans have a set repayment term, just 澳洲幸运5官方开奖结果体彩网:like conventional mortgages. The borrower makes regular, fixed payments covering both 澳洲幸运5官方开奖结果体彩网:principal and interest. As with any mortgage, if the loan is not paid off, the home could be sold to satisfy 澳洲幸运5官方开奖结果体彩网:the remaining debt.

A home equity loan can be a good way to 澳洲幸运5官方开奖结果体彩网:convert the equity you’ve built up in your home into cash, especially if you invest that cash in home renovations that increase the value of your home. However, always remember that you’re putting yo♛ur home on the line—if real estate values decrease, you c🧜ould end up owing more than your home is worth.

Should you want to relocate, you might end up losing money on the sale of the home or be unable to move. And if you’re getting the loan 澳洲幸运5官方开奖结果体彩网:to pay off credit card debt, resis⛄t the temptation to run up those credit card bills🐠 again. Before doing something that puts your house in jeopardy, weigh all of your options.

“If considering a home equity loan for a large amount, be sure to 澳洲幸运5官方开奖结果体彩网:compare rates on multiple loan types. A 澳洲幸运5官方开奖结果体彩网:cash-out refinance may be a better option than a home equity loan, depending on how much you need.”

—澳洲幸运5官方开奖结果体彩网:Marguerita Cheng, CFP, Chief Executive Officer, Blue Ocean Glob𝓀al Wealthꦯ

Special Considerations

Home equity loans exploded in popularity after the 澳洲幸运5官方开奖结果体彩网:Tax Reform Act of 1986 because they provided a way for consumers to get around one of its main provisions: the elimination of deductions for the interest on most consumer purchases. The act left in place one big exception: interest in the service of residence-based debt. 

However, the 澳洲幸运5官方开奖结果体彩网:Tax Cuts and Jobs Act of 2017 suspended the deduction for interest paid on home equity loans and HELOCs until 2026—unless, according to the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS), “they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.” For example, the interest on a home equity loan 澳洲幸运5官方开奖结果体彩网:used to consolidate debts or pay for a child’s college expenses is not tax deductible.

As with a mortgage, you can ask for a 澳洲幸运5官方开奖结果体彩网:good faith estimate, but before you do, make your own honest estimate of your finances. “You should have a good sense of where your credit and home value are 澳洲幸运5官方开奖结果体彩网:before applying, in order to save money,” says , author of The Loan Guide: How to Get the Best Possible Mortgage. “Especially on the appraisal [⛦of your home], which is a major expense. If your appraisal comes in too low to support the loan, the money is already spent”—and there are no refunds for not qualifying.

Before signing—especially if you’re using the home equity loan for 澳洲幸运5官方开奖结果体彩网:debt consolidation—run the numbers with your bank and make sure that the loan’s 澳洲幸运5官方开奖结果体彩网:monthly payments will indeed be lower than the combined payments of all your current obligations. Even thoꦅugh home equity loans have lower interest rates, your term 🔯on the new loan could be longer than that of your existing debts.

Home Equity Loans vs. HELOCs

Home equity loans provide a single lump-sum payment to the borrower, which is repaid over a set period of time (generally five to 15 years) at an 澳洲幸运5官方开奖结果体彩网:agreed-upon interest rate. The payment and interest rate remain the same over the li⛄fetime of the loan. The loan must be repaid in full if the home on which it is based is sold.

A HELOC is a revolving line of credit, much like a credit card, that you can draw on as needed, pay back, and then draw on again, for a term determined by the lender. The 澳洲幸运5官方开奖结果体彩网:draw period (five to 10 years) is followed by a repayment period when draws are no longer allowed (10 to 20 years). HELOCs typically have a variable interest rate, but some lenders offer 澳洲幸运5官方开奖结果体彩网:HELOC fixed-rate options.

Advantages and Disadvanta🥃ges of a Hom♕e Equity Loan

There are a number of key 澳洲幸运5官方开奖结果体彩网:benefits to home equity loans, including cost, but there are also drawbacks.

Advantages

Home equity loans provide an easy source of cash and 澳洲幸运5官方开奖结果体彩网:can be valuable tools for responsible 🉐borrowers. If you have a steady, reliable source of income and know that you will be able to repay the loan, then low-interest rates and possible tax deductions make home e🦩quity loans a sensible choice.

澳洲幸运5官方开奖结果体彩网:Obtaining a home equity loan is quite simple for many consumers because it is a secured debt. The lender runs a credit check and orders an appraisal of your home to determine your 澳洲幸运5官方开奖结果体彩网:creditworthiness and the CLTV.

The interest rate on a home equity loan—although higher than that of a first mortgage—is much lower than that of credit cards and other consumer loans. That helps explain why a primary reason that consumers borrow 澳洲幸运5官方开奖结果体彩网:against the value of their homes via a fixed-rate home equity loan isꦡ to pay of🐷f credit card balances.

Home equity loans are generally a good choice if you know exactly how much you need to borrܫow and for wha✃t. You’re guaranteed a certain amount, which you receive in full at closing. “𝓰Home equity loans are generally preferred for larger, more expensive goals such as remodeling, paying for higher education, or even debt consolidation because the funds are received in one lump su꧋m,” says , senior loan officer with CrossCountry Mortgage LLC in Portland, Maine.

Disadvantages

The main problem with home equity loans is that they can seem an all-too-easy solution for a borrower who may have fallen into a perpetual cycle of spending, borrowing, spending, and sinking deeper into debt. Unfortunately, this scenario is so common that lenders have a term for it: 澳洲幸运5官方开奖结果体彩网:reloading, which is basically the habit of taking out a loan to pay off existing debt and free up additional credit, which the 澳洲幸运5官方开奖结果体彩网:borrower then u💧ses to make additꦍional purchases.

Reloading leads to a spiraling cycle of debt that often convinces borrowers to turn to home equity loans offering an amount worth 125% of the equity in the borrower’s house. This type of loan often comes with higher fees: Because the borrower has taken out more money than the house is worth, the loan is not fully secured by collateral. Also, know that the interest paid on the portion of the loan that is above the value of the home is never tax deductible.

When applying for a home equity loan, there can be some temptation to borrow more than you immediately need because you only get tꦗhe payout once and don’t know if you’ll qualify for another loa🃏n in the future.

If you are contemplating a loan worth more than your home, it might be time for a reality check. Were you unable to live within your means when you owed only 100% of the equity in your home? If so, then it likely will be unrealistic to expect to be better off when you increase your debt by 25%, plus interest and fees. This could become a slippery slope to 澳洲幸运5官方开奖结果体彩网:bankruptcy and 澳洲幸运5官方开奖结果体彩网:foreclosure.

Home Equity Loan Requirements

Each lender has iౠts own💎 requirements, but to get approved for a home equity loan, most borrowers will generally need:

• Equity in their home greater than 20% of their home’s value
• Verifiable income history for two or more years
• A credit 澳洲幸运5官方开奖结果体彩网:score greater than 600

Though it is possible to get approved for a home equity loan without meeting these requirements, expect to pay a much higher interest rate through a lender that specializes in 澳洲幸运5官方开奖结果体彩网:high-risk borrowers.

Rates assume a loan amount of $25,000 and a loan-to-value (LTV) ratio of 80%. HELOC rates assume the interest rate during credit line initiation, after which rates can change based on market conditions.

Example of a Home Equity Loan

Say you have an auto loan with a balance of $10,000 at an interest rate of 9% with two years remaining on the term. Consolidating that debt to a home equity loan at a rate of 4% with a term of five years would actually cost you more money if you took all five years to pay off the home equity loan. Also, remember that your home is now collateral for the loan instead of your car. Defaulting could result in its loss, and losing your home would be significantly more catastrophic than surrendering a car.

The Bottom Line

A home equity loan can be a better choice financially 澳洲幸运5官方开奖结果体彩网:than a HELOC for those who know exactly how much equity they need to pull out and want the security of a fixed interest rate. Borrowers should 澳洲幸运5官方开奖结果体彩网:take out home equity loans with caution when consolidating debt or 澳洲幸运5官方开奖结果体彩网:financing home repairs. It is easy to end up 澳洲幸运5官方开奖结果体彩网:underwater on a mortgage if too much equity is pulled out, leaving a borrower with 澳洲幸运5官方开奖结果体彩网:ruined credit and a home in foreclosure.