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Key Points:
- Home equity is the value of your owned home portion, found by deducting mortgage balances from the house's market value. It can be accessed through home equity loans for financial needs.
- Pros and Cons: Home equity loans offer fixed rates, possible tax benefits, and sizable loans. Yet, risks include foreclosure, high closing costs, and potential debt escalation.
- Alternative Loan Options: Personal loans don't use homes as collateral but have higher rates. HELOCs provide flexible, variable-rate borrowing against home equity.
Home equity isn’t just a buzzword, it’s a powerful tool you can leverage to meet other financial goals. Whether you’re considering funding a home renovation, expanding your investment portfolio, or exploring other financial avenues like consolidating debt, understanding your home’s equity value is important. Below we will get into what equity on a house means, how to tap into it through a home equity loan, and explore its various uses, pros, cons, and more.
Home equity loans are an excellent financial tool, allowing homeowners to leverage their property’s equity
What is a Home Equity Loan?
A home equity loan allows homeowners to borrow money using the equity they have built up in their home as collateral. Equity is the difference between your home’s current market value and the outstanding balance on your mortgage - assets minus liabilities = equity. Think of it as the portion of your home that you truly “own,” not what you still owe the bank for. A home equity loan can provide access to substantial funds for various purposes based on this equity amount, such as renovations or other major expenses or even consolidating debt.
How Home Equity Loans Work
Firstly, you need to calculate how much equity you have. So what is equity on a house? It can be calculated by taking the current market value, either from an assessment or to the best of your knowledge, and subtracting any outstanding mortgage balance. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, your equity is $100,000.
After calculating your home equity, you may be able to borrow a portion of this amount through a home equity loan. Lenders typically allow you to borrow 80-90% of this value. From the example above, you may be able to borrow $80,000 to $90,000, depending on the lender.
A home equity loan is normally provided as a lump sum, and you repay it over a fixed term with fixed monthly payments. The interest rates are usually competitive because of the asset backing the loan, making them attractive for those who qualify. If you fail to make payments, the lender could foreclose on your property - so ensure it is something you are able to finance.
Pros And Cons of Home Equity Loans
Home equity loans come with many pros and cons to be aware of, some are listed below:
Pros:
- Fixed Interest Rates: These loans often come with a fixed interest rate, which helps with predictability in your payments.
- Potential Tax Benefits: Interest may be tax-deductible, but it is advisable to consult a tax professional beforehand.
- Access to Large Funds: Often, you can borrow a significant amount of money, especially if you have built up a large equity amount in your home.
Cons:
- Risk to Your Home: Failure to repay the loan amount to the bank can lead to foreclosure on your home.
- Closing Costs: Costs to receive the loan can be expensive, including all fees.
- Potential Debt Increase: If not managed properly, increasing your debt load can spiral into the need for further debt.
Understanding what is a home equity investment and how to handle the increased debt is important, so ensure you know what you are getting into beforehand.
How to Use a Home Equity Loan
You can use the funds for things like home renovations like upgrading a kitchen, adding or upgrading a bathroom, or constructing an outdoor deck.
Another use for a home equity loan is consolidating credit card debt. This can be a great way to combine multiple high-interest credit card balances into one loan, with likely a lower interest rate. This can simplify your financial management, possibly reduce monthly payments, and lower your overall interest expense. Just be aware that it is not an excuse to continue to build balances on your credit cards!
Whether improving your home or consolidating debt or otherwise, a home equity loan offers many opportunities to utilize your home’s value to meet financial goals and objectives. Use them wisely, and try not to abuse your increased debt load - it can result in the foreclosure of your home if you are not careful.
Average Home Equity Interest Rates
When you’re thinking of adding a home equity loan to your property, knowing what available interest rates are out there is important to make an informed decision. The rates you receive will vary based on the lender, your credit score, the loan amount, and the term length of the loan, among other factors.
As of August 2023 according to CBS News, the average national home equity loan rates are:
- Average Overall Rate: 8.49%
- 10-year fixed home equity loan: 8.62%
- 15-year fixed home equity loan: 8.58%
While this is much more expensive than just a short time ago, it is still likely far cheaper than holding a balance on your credit card. In addition, the interest may be tax deductible depending on how you use the funds.
Home Equity Loans Vs. Other Options
Home equity loans are not the only way to get funds if you are in need. There are a couple of other common ways to borrow money, like personal loans and home equity lines of credit (HELOC). Here are some notes about the two:
Personal Loans:
- Interest rates are often higher than home equity loans.
- These loans are often unsecured, meaning your home isn’t at risk.
- The application process is typically quicker and less stringent.
Home Equity Lines of Credit (HELOC):
- Interest rates are usually variable, which can lead to fluctuating payment amounts.
- HELOCs offer a revolving line of credit, meaning access to the funds is optional and not a lump sum like home equity loans. You only pay interest on the borrowed amounts.
- Repayment terms are more flexible, and you can pay interest only during the draw period.
Home equity loans provide a fixed amount with predictable payments, making them more suitable for large, one-time expenses. In contrast, personal loans might be preferred for those who do not want to use their home as collateral, and HELOCs offer more flexibility.
How to Apply for a Home Equity Loan
Applying for a home equity loan is a process, with the basic steps outlined below:
- Evaluate your needs: Determine how much money you need and the purpose of your loan.
- Check your equity: Calculate approximately how much equity is available in your home.
- Review your credit score: A strong credit score can lead to better interest rates.
- Compare lenders: It is best to shop around for the best rates available, as institutions vary with what they can and will offer.
- Submit an application: Complete the chosen lender’s application form.
- Provide documentation: Submit the lender’s required documents such as proof of income and outstanding mortgage balances.
- Wait for approval: The lender will take some time to assess your application and the property for which you are getting a loan.
- Close the loan: Sign the documents and receive the funds if approved.
Conclusion
Home equity loans are an excellent financial tool, allowing homeowners to leverage their property’s equity for various uses. Before entering into a contract, understand what home equity loans are, the pros and cons, and how they compare to other financial products. Consult a financial advisor if you have further questions or need extra information.
FAQ
Are home equity loans a good idea?
Home equity loans can be a common and effective way to finance larger expenses, depending on individual needs, equity availability, and financial stability.
How much equity can you borrow from your home?
Lenders typically offer up to 80-90% of your home’s value, minus any existing mortgage balance.
Are home equity loans tax deductible?
If the home equity loan is used to buy, build, or substantially improve your home the interest may be tax deductible, but consult with a tax professional to be sure.
Are home equity loans hard to get?
It will depend on many factors, but if you have a low credit score or insufficient equity, it may not be possible. Each lender’s requirements will be different so it would be best to check with several financial institutions.
Can home equity loans be fixed rates?
Yes, many home equity loans come with fixed interest rates.
Is home equity a liquid asset?
No, home equity is not considered a liquid asset. Home equity cannot be quickly converted to cash, you would need to sell the property or take out a loan to access the funds, which can take time.
Article Topics
Home Equity
Matthew is a freelance financial copywriter with 14+ years in financial services. He holds a Bachelor of Science degree in Economics with business and finance options and is a CFA Charterholder. He is from Vancouver, Canada, but writes from all over the world.
