Home Equity is the part of your home which you have paid off. However, a home equity loan is a fixed-cost installment debt that enables you to lend against a portion in your home. Many householders consider the home equity loan as a beneficial asset because its best part is that you do not have to do anything to pay off your monthly mortgage payments because the installment rate barely increases.
You can refinance your expensive mortgage with a home equity loan and afford large expenditures in your future. Besides, with home equity debts, you can also afford emergency outgoings and some extra expenses as well. However, with numerous benefits of a home equity loan, you may also discover some drawbacks which are also crucial to recognize before acquiring this loan type.
What is Home Equity Loan?
A home equity loan, also known as a second mortgage, allows you to borrow some money by lending a portion of your home. The debt amount is provided in a single repayment in monthly installments. This loan is protected by your property and can be used to associate mortgage or for other significant expenses, such as higher education, home renovation, or purchasing a new automobile. In this loan type, both the interest rates and monthly payments are stable, which provides you an expected repayment plan.
Practically, a home equity loan is the evaluated value of your house, excluding your loan balances or any excellent mortgage. Although the installment rate is fixed, it increases with the rise of the market value of your home and as you pay down your mortgage with time.
For instance, if you have purchased a home for $230,000 and its rate increases to $310,000, by keeping the time, your home’s worth, and other factors in mind, $80,000 has been added to your home’s equity. It means, if you were paying a $30,000 mortgage, it would be increased to $60,000 or maybe more.
Nevertheless, most creditors allow you to lend between 75 to 85 percent of your home’s equity which means that if you hold $100,000 in your home’s equity, you will get $75,000 to $85,000 for you. Usually, home equity debt requires a fixed interest rate which needs to be paid in a consistent monthly installment. However, the lifespan of installment varies from 5 to 30 years depending upon the loan amount and some factors.
Steps to Make Home Equity Loan
If you seek money to renovate your home or send your child for higher studies, obtaining debt against a portion of the house is the most helpful option. Since you use equity loans and use the money wherever you want with a fixed installment rate, there could be no greater option than this.
However, before lending your home for an equity loan, keep in mind specific steps to execute the process more efficiently.
- Increases your Home Equity
You can raise your home equity by paying off your mortgage or by making advancements in your home, which would ultimately influence your house’s worth.
- Calculate your Equity
Deduct your mortgage balance from the current market cost of your home. You can use an online home cost estimating tool such as Zillow’s Zestimate to get an estimate of your home’s present worth.
For instance, if you estimate the value of your property and the tool evaluates your home as $300,000 worth and you still owe $200,000, it means the approximate equity to your house would be $75,000.
- Consider Ups and Downs of Home Equity Loan
Though acquiring home equity debt for emergency expenses could be a fruitful choice for you, you must consider its gains and drawbacks before applying for this loan. You must keep in mind some risks of using your house as security because your house would always be at risk of losing your home in case of any default.
- See Whether You Qualify
Generally, lenders need 20% equity which is the least credit score, and a debt-to-income ratio should be less than 43% before applying for the home equity loan.
Home Equity Loan Pros and Cons
According to the IRS, if you use a home equity dent with the intention of developing your home, you would be required to pay the tax by deducting from your loan’s interest. Thus, the retrieved amount can be higher according to how much equity you have.
Anyhow, there are numerous benefits and downsides of home equity loans:
Benefits of Equity Loan
- The home equity loans can be benefited from your tax because it enables you to remove the interest on HELOC or home equity dent if you have used the money for investment development such as purchasing, constructing, or renovating your home, which safeguards your loan.
- Paying off high interest rates from a low-rate equity loan can also be very beneficial. Home equity loans have very low-interest rates as compared to traditional debts such as personal loans or credit card debt. It helps you save on your interest payments and improve monthly cash flow in case you need to reduce the high-interest loan.
Drawbacks of Equity Loan
- Since your home is secured in an equity loan, your creditor can close out your home if you fail to pay your installment. In case your house’s worth drops, you can also set up owing more on your home than its value.
- You may need to pay a fee for equity debt or HELOC. So you must pay attention to the annual percentage rate, which contains interest rates and loan fees as well.
- You should only acquire equity debt to invest in something which pays you back, such as renovating your home, paying for higher studies, or investing in some business. If you send this money to some useless activities, you would be at a great loss.
Alternative to Home Equity Loan
An alternative to home equity loans is the Home Equity Line of Credits, also known as HELOCs, which delivers a revolving credit line and works similar to a credit card. However, you can choose this option for a particular number of years which is known as the draw period.
Differences Between Home Equity Loan and HELOC
HELOC is the best alternative to a home equity loan, but you may explore some distinguished differences between the two:
- In HELOC, the interest rate is only applied to the borrowed amount. Instead, it is not applied to the new portion of the credit line.
- Payments may vary as per the owed amount and the interest rate.
- The interest rates are flexible which are based on the prime rate along with a set margin. If your prime rate is based on increases or reduces, the interest rate would also fluctuate. If the installments remain even after the draw period, a fixed repayment period will start automatically, which would be approximately a 20-year lifespan.
Other Alternatives to Equity Loan
Other HELOC, you may find some other multiple alternatives of home equity loans such as:
- You can refinance your mortgage at a lower interest rate and draw money at closing. The new debt would be higher than the existing one because the amount you withdraw will be added to your mortgage.
- Another appropriate option is to take out a personal loan. Many people do not want to secure their house for loans, so they avoid equity loans. Instead, they acquire a personal loan; however, you need a high credit score for this debt.
Eligibility Criteria for Home Equity Loan
Despite you getting an equity loan if you own a house, you still need to meet the criterion to qualify for this debt type. Although qualification requirements differ as per the creditor, you need a FICO score for sure which should be at least in the mid-600s. The greater the score, the more you have a chance to get the loan. Besides, some creditors analyze your credit report and require consistent credit card payments and mortgage installments for secure future payments.