What to Know About Home Equity Loans

 

You may have heard that home equity loans are a smart move when you need money for a big-ticket purchase. Home equity loans allow you to borrow money from yourself, essentially, using money you’ve invested into your home. Payments are scheduled on a monthly basis, and the interest rates are usually much more affordable than those attached to other personal loans.

 

Because home values continue to rise and interest rates have remained steady, home equity loans are gaining in popularity. Although these loans are a generally a good way to access the money you’ve put into your home, whether they’re right for you depends on your financial situation. Like any other type of financial decision, it’s important to understand the details of a home equity loan before you begin the process of securing one.

 

What is a home equity loan?
 

A home equity loan, or HEL, allows you to borrow a lump sum of cash using your home’s equity as collateral. Like a mortgage, a HEL is available with either a fixed or adjustable interest rate, and can be arranged to be repaid within 5 to 30 years.


What are home equity loans usually used for?

 

Because you’ve likely spent many years investing your hard-earned money into your home, it’s important that you only withdraw this money for important, necessary purchases. Banks normally require that your HEL be quite substantial, often tens of thousands of dollars; if that’s more than you need, think carefully before choosing a HEL.

 

Medical bills, college tuition, and home renovations are all examples of financially sound uses for home equity loans. They have set budgets, and once they’re paid for with the lump sum you’ve been granted, you can begin making your monthly loan repayments. You’ll be able to pay off both principal and interest from the outset, making a HEL superior to other personal loan options. Additionally, the interest you pay on your HEL is usually tax deductible just like the interest you have been paying on your mortgage.

 

How much equity does my home have?

 

The amount of money you can borrow depends on the difference between how much your home is worth and how much you still owe on it. This amount is called equity. Your lender will order an appraisal of your home to determine its current value, and then you will typically be permitted to borrow up to 80% of your equity.

 

What is the HEL application process like?

 

First you need to get pre-qualified. Visiting different lenders to compare rates and getting pre-qualified will tell you how much money you will be able to borrow, what your monthly payments are likely to be, and how much to budget for interest payments.

Once you’ve decided on a lender, contact them to begin the lending process. From there, a HEL will be much like the process you will recall from arranging your mortgage, so bring your proof of income and credit score paperwork with you. If there are closing costs, you will be responsible for paying them; then you can withdraw your lump sum.

 

What common mistakes should I avoid?
 

If you are unable to repay your HEL, the consequences are quite serious. Normally the lender will work with you to arrange feasible payments, but they can also choose to foreclose on your home if they believe you will not be able to repay the HEL in a satisfactory timeframe. Go over your budget carefully with your financial advisor, realtor, or accountant to ensure that a HEL is a good fit for your financial situation. Your home is at stake - do not choose a HEL without first properly scrutinizing your finances.

 

Another potential snag is early-termination fees. If there’s a chance that you’re going to be able to repay your HEL soon after arranging it, the lender might charge you an early-termination fee. However, not all lenders have such fees attached to their HELs, so if this is a concern for you, shop around to secure a loan from a lender who won’t penalize you for early repayment.