Home equity loans allow homeowners to borrow money by putting up their home as collateral. These loans are typically for a large sum of money and are most often used to make home improvements, but can also be used to pay off other debt or finance vacations or other luxury items. Since these loans use homes as collateral, they often carry a lower interest rate than other personal loans and as long as you are a responsible borrower, these consumer loans are a great option.
Millions of Americans utilize home equity loans and it has become one of the fastest-growing segments of consumer loans; new borrowing has nearly quadrupled over the past five years. While the point of these loans began as a means to building home equity, over the years consumers have also begun using them for other means. Reinvesting in your home is an easy way to raise the real estate value of your home and making improvements to your existing home often makes it more desirable to potential buyer’s when/if the time comes to sell.
There are two types of home equity lending: lines of credit and loans.
- Home Equity Lines of Credit. These work similarly to credit cards. Borrowers are given a credit limit which they can borrow against and by paying down the debt; more credit is freed up which you can then spend again. These lines of credit usually have variable interest rates typically tied to the prime rate. Unlike credit cards, these lines of credit are usually not open-ended.
- Home Equity Loans. These loans are installment loans just like a mortgage or car loan. A borrower is given a specific amount of money to spend, which you are given up front and then pay back according to a set time schedule. These loans come with fixed rates and payments.
Home equity loans can be obtained from any mortgage lender and it is easy to shop for rates online.
How do you know if you are getting a good deal?
- Compare rates. The rate you are offered on either type of home equity loan is tied directly to your credit score.
- Know the rules. If you have enough deductions and can itemize your tax return, then you are eligible to deduct the interest from home equity borrowing. Also, the break is limited to interest on loans below $100,000. If you borrow more than that, the interested paid on amounts over $100,000 are not deducted.
- Avoid fees. For borrowers with decent credit, you can often avoid application or real estate appraisal fees associated with borrowing against your home, although sometimes there are minimal recording fees and annual fees on credit lines.
- Risky business. It is important to know what is on the line when you choose to borrow against your home. These loans can be a good way to build long-term wealth, however it is important not to constantly drain that wealth away by continuing to borrow against your home.
- Save some room, headroom that is. Try and keep a cushion of at least 20 percent equity in your home. If your combined mortgage and home equity loan exceed 20 percent, you will pay a higher interest rate. However, sometimes mortgage companies will give borrowers a lower interest rate with a larger loan. As long as it stays within the 20 percent cap and are confident in your ability to pay back the amount, obtaining a lower interest rate is always a good idea.
Home equity loans have increasingly become a viable way for consumers to obtain low interest cash. These loans can be used for a variety of projects or desires, however, as with any loan or money borrowed, it is important to research before signing and ensure you are getting the best deal possible.