Should You Get a Home Equity Loan?
Home equity loans convert part of the value of your home into cash you can spend as you see fit. It can be a way to cover various expenses such as college tuition or home improvements. But it’s a debt that comes with big pros and cons, so it’s important to do your research when you’re asking yourself the question, “Should I get a home equity loan?”
What Is a Home Equity Loan?
A home equity loan is a loan that you can get based on how much equity you have in your home. To get the loan, you have to have equity in your home—that means you owe less on it than it’s worth. That’s because the loan is secured by the equity. You pay the loan back in monthly installments.
How Is Home Equity Calculated?
Home equity is calculated by taking the value of your home and subtracting how much you owe on it. For example, if your home is worth $300,000 and you owe $200,000, you have $100,000 in equity.
How Is a Home Equity Loan Different From a Home Equity Line of Credit?
A home equity loan and a home equity line of credit—called a HELOC—are slightly different. They’re both based on the equity you have in your home. But one is an installment loan, and the other is a revolving line of credit.
With a home equity loan, you get a lump sum of money. You pay that money back, with interest, in agreed-upon monthly payments.
With a HELOC, you get a credit limit as you might with a credit card. You can pull from that line of credit a little at a time, paying for things as you would with a credit card. You then pay the money back with interest and can borrow from the credit line again.
What’s Good About Home Equity Loans?
Here are some of the pros of home equity loans:
- They offer an option for financing lump sums of money for large expenses or purchases.
- Because they’re secured by your home’s value, they typically come with lower interest rates than unsecured personal loans do.
- Many lenders offer these loans to creditworthy borrowers, so you can probably shop around to find a good deal.
- If you opt for a fixed-rate loan, you know what you need to pay each month. This makes home equity loans a potentially beneficial way to consolidate high-interest debts.
- In certain cases, you might be able to take a tax deduction for interest you pay on your home equity loan.
What’s Bad About Home Equity Loans?
These loans can be a great option, but they’re not perfect for everyone. Here are some of the cons of home equity loans:
- Home equity loans use your home as collateral, which can be risky. If you can’t or don’t make payments as agreed, the lender can take legal action to force the sale of your home to recoup its losses.
- If your home value goes down after you take out a home equity loan, you could be underwater on your home. That means you owe more than the home is worth. That might make it more difficult to sell if you ever decide to do so.
- Home equity loans are a form of mortgage, so you will have to pay closing costs and other fees.
How Can I Qualify for a Home Equity Loan?
Qualifying for a home equity loan is similar to qualifying for a mortgage, although you might not need to go through as rigorous an underwriting process, and you won’t need a down payment.
First, you’ll have to find a lender that offers home equity loans and apply. Whether or not you’re approved—and what terms you’re offered—depends on factors such as your credit score, your income, your current debt and the equity you have in the home.
According to the FTC, most lenders limit how much you can borrow to around 85 percent of your equity. So, if you have $100,000 in equity, the most you could borrow would be $85,000. And that also depends on your credit, your income and other factors that indicate your ability to repay the loan.
When Should I Get a Home Equity Loan?
Home equity loans aren’t just free money. You pay for this funding in the form of fees, such as closing costs, and interest. And since you’re tying your home up in the loan, you don’t want to take one out without good reason.
What a good reason is depends on your unique situation, but you want to choose worthy endeavors that provide you some value in return. These are some common reasons why people take out home equity loans.
When You Want to Pay for College
If you have enough equity in your home, you might be able to get a loan to cover the cost of college tuition for yourself or a child. If you can get a loan with an interest rate lower than current student loan rates, this might save you money in the long run.
When You Want to Consolidate Debt
The expense of a home equity loan might be well worth it if you can use the funds to pay off high-interest debt such as credit card balances. In most cases, the interest on your home equity loan will be less than the interest on personal loans or credit cards. And you can consolidate multiple debts into a single loan payment, which might be easier to budget for.
When You Have Emergency Expenses
Home equity can be your ticket to covering emergency expenses such as an unexpected medical bill or repair. Home equity loans don’t take as long to finalize as mortgages, but they aren’t overnight funding options. Expect to wait two weeks to a month for the funds to come through.
When You Want to Remodel Your Home
One reason many people get a home equity loan is to invest the money back into their home. The idea is that, by remodeling in ways that increase your home’s value, you actually build more equity. This might be an option if you want to sell your home but need to make repairs or add value first.
When You Want to Make an Investment
This is a riskier option, but if you need money to fund an investment, you could draw it from your home equity. The risk is that the investment doesn’t pan out and you’re left paying a loan without getting anything of value in return. Do your due diligence and consult with a financial advisor, if possible, to ensure you’re fairly confident in an investment before you take out a home equity loan for it.
Home Equity Loans and Poor Credit
It’s not impossible to get a home equity loan with bad credit. If you have enough equity built in your home, a lender might be willing to provide a loan for a small percentage of the equity despite your credit score. That’s because the lender knows they can recoup losses if you don’t pay by forcing the sale of your home.
If you’re seeking a home equity loan with bad credit, make sure you carefully review the details and offer. You may end up paying more fees and interest than it’s worth. And if you’re trying to get a home equity loan because you can’t pay your other bills, you might want to consider other options such as credit counseling or bankruptcy. Adding more debt rarely helps you pay off debt you’re already struggling with.
Is a Home Equity Loan Right for Me?
Whether or not you should get a home equity loan depends on your situation and needs. Make sure you understand your financial situation and think through the loan fully before you commit.
And be wary of home equity loan scams. While loans against your equity are a legitimate financial product, some companies charge exorbitant fees and interest or purposefully offer you a loan you’ll struggle to pay back. The goal in these cases is to force you to default so that the company can force a home sale and quickly get back the loan amount plus fees, interest and penalties.
To learn more about what’s on your credit report so you can guess what kind of home equity loan terms you might be eligible for, check out the services offered by CreditRepair.com.
from a Credit Expert