Home Equity Loan

Home Equity Loan
Home equity loans allow you to borrow against the equity in your home. They can provide money for a major purchase, but come with the risk that you’ll lose your home if you can’t pay them back.

What is a Home Equity Loan?

A home equity loan is a type of large, secured loan. To get one, you offer the equity in your home as collateral. Equity is essentially how much of your home you’ve paid for. If you default on your home equity loan, your lender can foreclose on your home and sell it to recoup their losses.

What is the Difference between a Home Equity Loan and a Home Equity Line of Credit?

These loans have a fixed rate, meaning the interest rate will never vary for the duration of the loan. This is the main difference between a home equity loan and a home equity line of credit. A home equity line of credit (HELOC) comes with an adjustable rate, making it a much more volatile loan. While home equity loans usually work much like a mortgage in that you make monthly payments at a fixed rate for a fixed amount of time.2

How does a Home Equity Loan work?

You can use the money from home equity loans in many different ways: make home repairs, pay off credit card debt or finance a college education. What you can’t do is purchase a home—simply because you must already own a home to get a home equity loan.

To get a home equity loan, you need to have your home appraised. This will determine how much the home is worth. If a lender chooses to offer you a loan, the amount you receive will be based on the value of the home and how much of it you own.

Most lenders cap home equity loans at 80 or 90 percent of your equity.1 Still, this can amount to a lot of money. You choose whether you want it in a single lump sum or through a line of credit—also known as a “home equity line of credit,” or HELOC—which allows you to borrow as much or as little from a predetermined amount. If you choose a lump sum, you’ll pay a fixed rate over a set period of time—usually five to 15 years.2 If you choose a HELOC, you’ll pay interest only on the money you borrow and not the full amount of the credit line.

How are interest rates determined for Home Equity Loans?

If you receive a home equity loan, the interest rate you pay will be determined by a number of factors. The value of your home and whether your lender considers it likely to sell in the event of foreclosure is one major consideration.

Another major consideration is your credit score. If your credit score is 740 or above, you might be able to get a rate of five percent or so. If your score is lower—say around 630—you might pay almost twice that much.3 Debt-to-income ratio also has an impact, with most lenders offering better rates if your debt is less than 40 percent of your income.4

Home equity loans are also sometimes called “second mortgages.” This is because they are secured by your home, just as your first mortgage is. They’re riskier for lenders, who are repaid only after the lender for the mortgage if you default, so the interest rates are typically higher.

Why do people get Home Equity Loans?

Home equity loans are good for a lot of things: you might finance home repairs, consolidate debt, or pay for a college education. However, because you might lose your home if you default, they should be reserved for important, necessary expenses.

Are interest payments on Home Equity Loans tax deductible?

Yes. To encourage home purchases, the federal government lets you deduct the interest you pay on your home equity loan from your taxes.5

References:

  1. Geffner, Marcie. (2015, July 31). How much equity can you cash out of your home? Retrieved from http://www.bankrate.com/finance/home-equity/how-much-equity-can-you-cash-out-of-home.aspx
  2. Investopedia. Home-equity loan. Retrieved from http://www.investopedia.com/terms/h/homeequityloan.asp.
  3. Latham, Saundra. (2017, January 3). Best home equity loan rates for 2017. Retrieved from http://www.thesimpledollar.com/best-home-equity-loan-rates/
  4. Da Costa, Polyana. Hoe equity loans, HELOCs catch fire again. Retrieved from http://www.bankrate.com/finance/home-equity/home-equity-loans-helocs-available-again-1.aspx
  5. TurboTax. (2016). Are home interst loans deductible from taxes? Retrieved from https://turbotax.intuit.com/tax-tools/tax-tips/Home-Ownership/Are-Home-Interest-Loans-Deductible-From-Taxes-/INF14356.html