Even though the pandemic presented new difficulties for virtually every aspect of the economy, the US housing market has maintained its surprising resilience until 2021.
According to the latest figures from the National Association of Realtors, the median price of an existing single-family home increased by nearly a record 22.9% between June 2020 and June 2021. Meanwhile, interest rates on various financial instruments remain dangerously close to all-time lows.
Many homeowners have wondered if now is a good time to cash out some of their home equity after years of appreciation. Educating yourself on home equity products is a good idea if you have a sizable amount of money stuck in your house and want to free up that money to go toward other investments or expenses. Let’s delve into home equity loans and why now could be an excellent time to apply for one.
What exactly is a “home equity loan”?
A home equity loan, often known as a second mortgage or HELOC, is a type of secured loan that is backed by the value of your property. A home’s equity is its current market value minus any outstanding mortgages or loans secured by the property. A home equity loan is typically taken out in addition to the mortgage.
A home equity loan is a type of secured loan in which the borrower agrees to repay the lender a set sum of money over a set period of time. The interest on a home equity loan is often fixed, as are the monthly payments.
A home equity line of credit (HELOC) is an alternative to a home equity loan that may appeal to some borrowers. While both provide access to the same amount of money, a home equity loan pays out all of the cash at once. In contrast, a home equity line of credit provides a line of credit that can be drawn upon as needed.
A home equity loan or line of credit may also help you save money on your taxes. There have been some changes to the laws regarding the deductibility of interest on home equity loans and lines of credit. However, if the money is used for improvements to the home, then the interest is still deductible. Due to this, home equity loans may be significantly better than other forms of credit.
A lender can foreclose on your property to collect on a home equity loan or line of credit if you can’t make the payments. The equity in your home guarantees the loan or line of credit. Therefore, you should only accept as much debt as you can reasonably afford and make a strategy to repay your home equity loan on time.
How to get a home equity loan
First, you must establish that you have sufficient home equity in your house to obtain a home equity loan. Most home equity loan providers will limit the sum of your mortgage plus home equity loan to no more than 85% of your house’s worth.
A combined mortgage and home equity loan might bring your total debt to $340,000 if your property is worth roughly $400,000, for example. So, if your mortgage is $300,000 and you have $0 equity in your property, you may be able to take out a home equity loan for an additional $40,000.
Having your property assessed to find out what it’s worth in the current market may be necessary, depending on your circumstances. Your home equity lender typically handles the process; however, they may charge you a fee for the appraisal.
Your credit score is also essential if you want a home equity loan. While the exact requirements vary from lender to lender, a reasonable starting point is a FICO score of 670 or higher. A “very good” FICO score, which is often 740 or higher, will increase your chances of qualifying for the best terms and rates on a home equity loan.
Aside from having sufficient home equity, you’ll also need to show that you can afford the loan payments. Paystubs or evidence of other regular income, such as from investments or self-employment, will usually suffice. You will likely be approved for a home equity loan based on your combined income if you and your spouse are both listed as owners on the mortgage.
Lastly, a home equity lender will look at your debt-to-income ratio, or the amount of debt you have relative to the amount of money you bring in each month. Creditors tend to favor borrowers with a 43% or lower debt-to-income ratio.
When would it be wise to take out a loan against one’s home’s equity?
Do not take out a home equity loan, or any other type of loan, if you intend to use the money to gamble at a casino. However, home equity loans can be put to good use and even result in cost savings in the long term in several situations.
The following are some circumstances in which it makes sense to take out a home equity loan:
- If you don’t have the funds to take care of a sudden emergency need, getting a home equity loan can help you receive the funds you require without being required to pay an arm and a leg for the privilege. This is especially helpful if the expense is unexpected.
- Consolidating debts is a good option if you have high-interest credit card debt or a high-interest personal loan and wish to save money overall. You can consolidate your obligations into one manageable monthly payment and save thousands of dollars in interest charges by taking out a home equity loan instead of a credit card or a personal loan.
- Many families use the equity in their homes to defray the cost of higher education for their children and grandchildren, allowing them to delay taking out expensive student loans and incurring substantial long-term debt.
- Home equity loans are a popular way for homeowners to finance large-scale renovations like kitchen makeovers, second-story additions, and flooring replacements. Home equity loans are viable because they often have low fixed interest rates.
Suppose your credit score qualifies you for a lower interest rate on a home equity loan. In that case, it may make financial sense to utilize one rather than a credit card or other type of loan.
To be clear, when you take out a home equity loan to pay off high-interest credit card debt or a personal loan, you are switching your unsecured debt to a secured obligation. If you don’t repay the money, your home is in jeopardy, but your interest rate will go down. Leaving debt on an unprotected vehicle like a credit card reduces this likelihood. Yet, the repercussions of not paying your debts remain the same.
The fees associated with a home equity loan
Like many other types of loans and investments, home equity loans might come with hidden costs if you don’t know where to search. Application and loan processing fees, as well as origination fees of up to 5% of the loan amount, are all legal in the eyes of the Federal Trade Commission (FTC).
An assessment of your home’s value may also be required to guarantee the loan’s sufficiency, and you may incur additional costs for document preparation, recording, or a broker’s services. Asking about costs up front and searching for home equity loan providers with minimal “additional” fees and closing costs is a must.
Before committing to a home equity loan, it’s essential to go around and compare interest rates and fees from different institutions. One option is to use a service like LendingTree. In this online marketplace, you may submit your information once and receive competing loan offers from different lenders.
Options to take into account besides home equity loans
Although a home equity loan may seem like a good option if you’re in the market for a loan, there are alternative ways to acquire the funds you require. Therefore, before you decide to go through with a home equity loan, you might also think about the following:
Equity loans and lines of credit (HELOC)
The principle behind a home equity line of credit (HELOC) is the same as that behind a home equity loan: you can get cash by borrowing against the equity in your property. However, HELOC functions as a credit line that can be tapped into as needed, with repayment limited to the actual amount borrowed.
A HELOC may be the way to go if you’d rather pay back your loan in installments rather than all at once. Like credit cards, home equity lines of credit (HELOCs) have variable interest rates. Still, HELOCs are backed by the equity in your home instead of a credit score. You can only borrow up to 85% of your house’s value with a HELOC, the same as with a home equity loan.
Personal loans
A personal loan allows you to borrow a defined sum of cash with a set monthly rate and a fixed payback term. On the other hand, personal loans do not require any sort of collateral, so you can get one without worrying about your credit score or the value of your property.
A personal loan may be preferable to a home equity loan if you do not own a home or do not have enough equity in your primary residence to secure a home equity loan.
Mortgage Refinancing
Finally, keep in mind that you can take advantage of your home’s equity by restructuring your mortgage. While this is typically more difficult than obtaining a home loan, the long-term interest reduction may be well worth the effort if you can secure a lower interest rate or more favorable loan terms.
Simply put, a mortgage refinance is the process of getting a new mortgage in place of your existing one, usually at a more favorable interest rate. Even with a reduced rate, your monthly payments may increase if you have already paid off a sizable chunk of your mortgage. You should sit down and figure out how much you will save after fees if you decide to refinance your mortgage.
Credit Cards
Credit cards with introductory interest rate offers are worth looking into if you need access to a line of credit to make certain purchases and don’t anticipate taking over a year to pay off your debt. You can earn rewards on your purchases with many of the best options while also paying no interest on purchases or balance transfers for 15 months or more.
A credit card may be a valuable financial tool if you need access to a small sum of cash and can pay it back promptly. Don’t do this unless you’re confident in your ability to repay the debt before your credit card’s introductory APR period ends.
Should you consider taking out a loan against the equity in your home?
Although home equity loans can be a good option for many people, this isn’t always the case. However, a home equity loan may not be the best option for everyone; it is worth considering if you want to access the equity you’ve built up in your home but don’t want to go through the headache of refinancing your mortgage.
Home equity loans are an attractive alternative because the interest you pay may be tax deductible if the money is used to improve your primary residence.
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