You’re considering taking out a home equity loan to garner some extra cash, but you know there are risks and that such loans aren’t a good fit for everyone. But generally, are home equity loans a good idea? Read on.
What is a Home Equity Loan?
Such a loan entails you borrowing money against the equity you’ve established in your home. Equity is the difference between your house’s market value and the amount you owe on your mortgage. The loan is basically a second mortgage.
Your home is collateral for the loan, meaning you could lose it if you don’t make payments. That’s a risk you must consider.
What’s so Great About Such Loans?
Because these loans come with fixed rates, there’s no concern about fluctuating rates. This means that your payment is the same each month.
And with a home equity loan, you can pay for large purchases over time, rather than all at once. Also, because the loan is secured, your interest rate will be low, compared with what you’ll get with most other types of loans and what’s on credit cards. Having said that, your rate will ultimately hinge on your income and credit history.
Further, after you’re approved, your loan can be processed within days. You’ll also likely be able to deduct interest paid on your loan on your taxes.
How Can I Use the Loan?
The sky’s the limit. Naturally, you can use it for home improvement, but there are other potential uses, including:
- To establish an emergency fund
- To erase or consolidate high-interest debt
- For investments
- To pay cash for a vehicle
- For medical bills
- To start your own business
- To cover a wedding
- For travel
- To fund your or child’s education
How Do Such Loans Work?
For starters, you’ll need at least 20 percent equity in your home. Further, you’ll need a credit score of at least 680, in addition to sufficient income. Lenders also want to see a low debt-to-income ratio, which is the percentage of your monthly gross income that goes to debts.
In terms of how much you can get, you can usually borrow up to 80 percent or 85 percent of your home’s value. Note that with a home equity line of credit (HELOC), the amount you can borrow hinges on your credit score as well as the amount of equity you have. In that case, a HELOC loan calculator can help you determine your monthly payment and rate. In that way, consulting the HELOC calculator at bills.com is a good idea.
With a home equity loan, your interest rate will be fixed. This means that you must pay both the principal and interest in fixed installments over the loan’s life.
While you’ll usually have between five and 30 years to repay the loan, borrowers who choose shorter terms often wind up with better rates.
Are Home Equity Loans a Good Idea?
Such a loan might be a good move for you if:
- You’re eligible for a good interest rate
- You know the lump sum amount you hope to borrow
- You want the stability of fixed-rate payments
- You plan to improve your home, which can get you a tax deduction
On the other hand, a home equity loan may not be the best idea if:
- You can’t manage your first mortgage plus the new loan
- You don’t want to pay high closing costs of between 2 percent and 5 percent of your loan amount
- You aren’t sure how much you’ll need, which might necessitate an additional loan
- You’re mulling selling your home soon
So, are home equity loans a good idea? As you can see – it depends. Choose wisely.