As you make payments on your home loan, you’ll build equity. Equity is the amount of your home that you’ve paid off, and it can be used as collateral for further financing. A home equity loan is one way to do that.
Determining if this is right for you is a matter of weighing home equity loan pros and cons and seeing how those would factor into your current situation.
Pros Of Home Equity Loans
Some of the advantages of home equity loans include those described below.
Favorable interest rate
In general, home equity loans have much lower interest rates than credit cards or personal loans since your home is being used as collateral. The lower rate allows you to borrow a sizeable amount with comparatively low total interest.
Also, these loans usually have fixed rates, so your monthly payments won’t fluctuate.
Lump sum payment
A home equity loan gets you a lump sum payment for the full amount of the loan, making it useful for handling large expenses where you know exactly how much things will cost.
By contrast, other options such as a home equity line of credit (HELOC) don’t give you a lump sum payment.
Potential tax benefits
A home equity loan may qualify for certain tax benefits if it’s used to make improvements to your house. In that case, you’d likely be able to deduct the interest on your loan payments from your taxable income, potentially reducing the amount you have to pay the IRS.
Finally, home equity loans are flexible in that you can use your lump sum payment for whatever you desire. Of course, that doesn’t necessarily mean that you should, but you have the freedom to use your funds as you see fit.
Cons Of Home Equity Loans
While a home equity loan can be beneficial in the right circumstances, it does have its potential drawbacks.
One of these drawbacks is simply the fact that you’re taking on more debt. If you’re still making mortgage payments, you’ll have to add home equity loan payments to your monthly expenses.
That could limit your ability to borrow funds in the future since many lending options have debt-to-income requirements. If your total amount of monthly debt is above a certain percentage of your income, you might not qualify for certain loans.
By securing your loan with your home as collateral, it does potentially put your home at risk. If you default on your home equity loan, it may mean losing your home.
Another (more likely) scenario is ending up “underwater” in the loan. If you owe more on your home equity loan than your home is actually worth, it’s referred to as being “underwater” or “upside-down” in the loan. This could be problematic if you need to sell or borrow against your home’s equity in the future.
As with many borrowing options, home equity loans have a full closing process, and that will mean fees. For that reason, it’s advised that you evaluate your current expenses and options to make sure the closing costs and fees are worth it.
Recommended Uses For A Home Equity Loan
A home equity loan is best used for the following purposes.
Making home improvements
Improvements that boost your home’s value can be a great way to use a home equity loan. Not only do you add value (and thus more equity) to your home, you might also qualify for the tax benefits described above when doing so.
Handling emergency expenses
Sudden large expenses such as hospital bills, home repairs, and the like can be difficult to manage without some form of financing. With less interest than personal loans or credit, a home equity loan can be a great way to tackle these expenses.
An investment that improves your future is another good way to use a home equity loan. The result should be some kind of return, such as dividends on monetary investments or better income resulting from higher education.
Large amounts of high-interest debt can be replaced by a home equity loan, consolidating it all into one monthly payment at a reasonable rate. If the total costs of the loan are less than the interest and other drawbacks you’d face with your current debts, and if you qualify, a home equity loan could be a fantastic option.
When Not To Use A Home Equity Loan
While you can use a home equity loan for anything, some uses that aren’t worth it include:
- Recreational vehicles
- Other unnecessary expenses
Put simply, make sure you borrow only what you need and with the right purpose.
Qualifying For A Home Equity Loan
Home equity loans have certain requirements, including those described here.
First off, you need enough equity to cover your expenses. Usually, lenders won’t lend more than 80% of the value of your collateral, which is your home’s equity in this case. As such, your borrowing limit would typically be 80% of however much of your home you’ve paid off.
Minimum borrowing amount
Some lenders have minimum borrowing amounts, and some don’t. In either case, most home equity loans don’t get much lower than $10,000. Whatever amount you need to borrow, it should be enough to warrant a home equity loan.
Your income needs to be high enough to handle the extra debt you’ll be taking on. If it’s not enough, another financing option may be more worthwhile.
Finally, good credit is recommended. Low credit makes it harder to get approved, and it will usually result in a higher interest rate.
Consult with your lender
Ultimately, to get a home equity loan, you’ll need to consult with your lender. They’ll advise you on the best course to take and help you make the right decision for your financial situation.
Weighing Home Equity Loan Pros And Cons
Understanding the benefits and disadvantages of home equity loans is an important piece of making the right decision for your financial well-being.
At GHS FCU, we offer home equity loans featuring same-day prequalification, competitive rates, fast closing, and more.