Learn the advantages of home equity loans, including how they work and who can benefit from them. A home equity loan might just help you reach your financial goals.
How do home equity loans work? That’s a question you’re probably asking yourself if you need money for home improvements, sending a kid to college or consolidating high-interest credit card debt, for example. And, with home values rising in many markets around the country, a home equity loan could be a great way to access the cash value of your house to reach some of your financial goals.
But what are home equity loans? And what do you need to do to get one?
“Equity” is a term used to refer to the market value of the interest in your home — that is, the difference between how much you owe on your mortgage and how much your home would be worth if you sold it today. A home equity loan helps you cash out some of the portion of your home’s value that’s yours free and clear, so you can spend the money on renovations and improvements or other expenses. Let’s take a look at how home equity loans work, and how they can benefit homeowners.
How Home Equity Loans Work
If your home is worth more than you owe on your mortgage, the difference between what you owe and what your home is worth is known as the equity. So, if you owe $250,000 on your mortgage, but your home is worth $375,000, you have $125,000 in equity. Home equity loans let you borrow against the equity in your home, but you may not be able to borrow the entire amount; most banks will let you borrow about 80 percent of the equity value in your home.
Basically, you’ll be taking a second mortgage on your home, and you’ll have to pay closing costs and monthly payments. If you can’t make the monthly payments, the lender could foreclose on your home. And you’ll need to meet loan requirements in order to qualify, which vary from lender to lender but include a minimum credit score, a solid income history and a low debt-to-income ratio. Most will also require you to have a certain amount of equity in your home, typically at least 20 percent.
Benefits of Taking Out a Home Equity Loan
If you need money, a home equity loan has its benefits. For one thing, it’s definitely cheaper than a credit card and it’s also usually cheaper than taking out a personal loan. Even though home equity loans have closing costs, which personal loans do not, interest rates for home equity loans are usually lower because they are secured by your property. Typically, interest rates for home equity loans are also fixed.
Because of the low interest rates on most home equity loans, borrowing against the equity in your home may be a good way to consolidate higher-interest debt, such as credit card debt. You can ditch the high APR in favor of a low monthly payment. However, make sure you have a plan in place to pay off the home equity loan and keep from acquiring more credit card debt.
A home equity loan can also allow you to borrow a substantial amount of money, usually much more than you can get in a personal loan. You can get the money as a lump sum payment if you take a traditional home equity loan, or you can choose a home equity line of credit and borrow exactly the amount you need.
Interest paid on a home equity loan may be tax-deductible, provided you used the money to improve or renovate the home you borrowed against. According to the Tax Cuts and Jobs Act of 2017, homeowners are allowed to deduct the interest paid on a home equity loan up to $100,000, but only if the loan is used to improve or renovate the property that secures it. However, you can only deduct interest on mortgages up to $750,000, so if your home equity loan puts you above that limit, you may miss out on some of the tax benefits.
A home equity loan or line of credit can also help you set up an emergency fund for your household. While personal finance experts recommend having six months’ worth of expenses stashed away in a savings account in case you lose your job, rack up some medical bills or face another financial hardship, that’s easier said than done. A home equity loan can give you the financial flexibility you need in an emergency situation because it allows you to access a fairly substantial sum of cash relatively quickly.
Have you been thinking about cashing out the equity in your home? A home equity loan has many benefits for homeowners looking to renovate, pay tuition or fund a major purchase. Next time you need some money for a major expense, consider this financial alternative.