Is a Home Equity Loan a Good Idea? – Forbes Advisor
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For homeowners looking to use their home‘s equity for extra money, a home equity loan could be a good option. However, this type of loan also comes with risks that you should keep in mind, such as: B. The possibility of losing your home if you don’t keep up with your monthly payments.
Here’s what you should know before you take out a home equity loan.
What is a Home Equity Loan?
A home equity loan is essentially a second mortgage that allows you to borrow against the equity in your home, which is the difference between the value of your home and what you still owe on your first mortgage. This can help you access extra money when you need it.
How Does a Home Equity Loan Work?
Home equity loans are offered by a variety of mortgage lenders. As with most loans, you typically need good to excellent credit (that is, a credit score of at least 680), a stable income, and a low debt-to-income (DTI) ratio to qualify for a home equity loan. You must also have enough equity in your home – usually at least 20%.
With a home equity loan, you can generally borrow up to 80% or 85% of the value of your home, depending on the lender and your financial profile. If you are approved, you will receive a lump sum to use however you wish, e.g. B. to cover large expenses like home renovations or unexpected medical bills.
Home equity loans come with fixed interest rates, which means you make payments over the life of the loan to cover both principal and interest in fixed installments. The repayment periods are usually between five and 30 years. Keep in mind that lenders usually offer better interest rates to borrowers who choose shorter terms.
When to Get a Home Equity Loan
Here are some situations where taking out a home equity loan might be a good idea:
- You can qualify for a good interest rate. Because a home equity loan is secured by your home and therefore less risky for the lender, it typically carries a lower interest rate than an unsecured personal loan or credit card. If you have good credit, you have a better chance of qualifying for the lowest interest rates available, lowering your overall borrowing costs.
- You know exactly how much you need to borrow. Unlike a home equity line of credit (HELOC), a home equity loan is paid out as a lump sum. This can be helpful if you know exactly how much you need to borrow.
- You want stable payments. Because home equity loans are offered at fixed rates, your payments won’t fluctuate like they do with a HELOC or variable rate credit card.
- You qualify for a tax deduction. You can deduct interest on home equity loans from your federal income taxes if you use the funds to “purchase, build, or substantially improve your home,” according to the IRS.
When not to get a home loan
While a home equity loan can be a good option in some cases, taking out one has several risks that you need to be aware of. If you are considering a home equity loan, here are some scenarios where it might be better to look for other alternatives:
- You could risk losing your home. In addition to the amount you still owe on your first mortgage, taking out a home loan means you have another large loan to pay off at the same time. And like a typical mortgage, your lender could foreclose on your home if you fail to make your payments. If there’s no question that you’ll be able to manage two loans, don’t get a home equity loan.
- You have to pay high closing costs. As with your first mortgage, you must pay closing costs when you take out a home equity loan. These can range from 2% to 5% of your loan amount, which could seriously affect your cash reserves.
- You don’t know how much to borrow. If you end up needing more money than you borrowed on a home equity loan, you will need to apply for another loan. In this case, it might be better to opt for a revolving line of credit that allows you to borrow repeatedly, e.g. a HELOC.
- You are thinking about selling your house soon. If you decide to sell your home, you need to earn enough from the sale proceeds to pay off both your first mortgage and your home equity loan. This could result in you receiving very little – or even no – cash proceeds from the transaction.
Alternatives to a Home Equity Loan
Here are some alternatives to consider if a home equity loan doesn’t seem right for you.
- HELOC: Unlike a home equity loan, a HELOC is a revolving line of credit that you can draw and repay repeatedly. This could be a good option if you have a long project with fluctuating costs to cover. Remember, like a home equity loan, a HELOC is secured by your home and you risk foreclosure if you fail to make your payments.
- Private loan: With a personal loan, you can typically borrow up to $100,000, depending on the lender. Most personal loans are unsecured, making them less risky for the borrower than a home equity loan. However, the downside is that you will likely have a higher interest rate.
- Credit card: Another revolving line of credit is a credit card. Some cards come with an introductory offer of 0% Annual Percentage Rate (APR), meaning you could avoid paying interest if you pay back your card before this period is over. But if you can’t pay off the card on time, you could face high interest charges — and credit card interest rates are typically higher than home equity and personal loan rates.
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