FINANCIAL ADVICE | home improvement
What is a Home Equity Loan?
Published February 6, 2019
- The most common uses for home equity loans are to finance major expenses, such as:
- How much you can borrow is partially based on a combined loan-to-value.
- Lower interest rates and potential tax deductibility.
A home equity loan is a type of loan that allows you as a homeowner to borrow against the equity (the difference between your home’s market value and how much you still owe on the mortgage loan) of your home. Similar to your mortgage, a Home Equity Loan or Home Equity Line of Credit is secured by your home, and the interest you pay on the loan is often tax-deductible. And just like a mortgage, it must be repaid in full if your home is sold before the loan is paid off.
Why Get A Home Equity Loan?
Over the life of your mortgage loan, the payments you’ve made have helped you build value in your home that can be used to secure a home equity loan. Home equity loans can be a good solution to pay off high-interest loans such as credit cards, personal loans, and other types of unsecured debt.
The most common uses for home equity loans are to finance major expenses, such as:
- Medical bills, unplanned surgeries, or procedures not covered by insurance
- Home improvements and renovations
- Funding your children’s college education
- Consolidating high interest credit cards into one manageable payment
The interest rate on a home equity loan – although higher than that of a first mortgage – is much lower than rates on credit cards and other consumer loans. As such, the number one reason consumers borrow against the value of their homes via a fixed-rate home equity loan is to pay off credit card balances (according to bankrate.com).
Interest paid on a home equity loan may also be tax deductible, so by consolidating debt with your home equity loan, you get a single payment, a lower interest rate, and potential tax benefits.
How Much Can You Borrow?
How much you can borrow is partially based on a combined loan-to-value (CLTV) ratio of 80% of your home’s appraised value. Simply put, the sum of the balances of your home equity loan and your mortgage cannot exceed 80% of your home’s appraised value, according to the state of Texas’ guidelines (many other states require a max LTV of 80% as well).
Once you determine your available equity and whether you have enough to get the loan you want, you’ll want to determine the actual loan amount you want. Credit Union of Texas recommends using a Home Equity Payment Calculator to figure out a loan amount and monthly payment you can afford. The interest rate of your loan depends on your credit score and payment history.
Is a Home Equity Loan a Good Idea?
Lower interest rates and potential tax deductibility make it a sensible alternative to other types of loans and can be a financially valuable tool for you if you:
- Are financially responsible
- Have a steady, reliable source of income and know that you will be able to repay the loan
- Know how much you need to borrow and what you’ll use the money for. You’re guaranteed a certain amount, which you receive in full at closing
A home equity loan is best suited to people who need cash to pay for a single major expense, like a home renovation project. It’s not a good solution if you need to borrow a small amount of money.
Home Equity Loans vs. HELOCs
Home equity loans come in two varieties – installment loans with fixed rate and term, or lines of credit (HELOC). Fixed-rate loans provide a single, lump-sum payment to the borrower, which is repaid over a set period of time (generally five to 15 years) at an agreed-upon interest rate. The payment and interest rate remain the same over the lifetime of your loan.
Home equity loans are sometimes confused with HELOCs. They are similar, but not the same. A HELOC is a line of revolving credit that you can borrow from and pay back as needed. The interest rate is adjustable and can change as often as quarterly. Alternatively, a home equity loan is a single, lump-sum loan that typically has a fixed interest rate and term. Home equity loan payments stay the same throughout the life of the loan until it is either paid off or refinanced.
So, let’s recap the basics of home equity loans & HELOCs:
- The home equity loan process takes a minimum of 30 days due to state regulations
- You can only take out one home equity loan or HELOC per year
- You can't owe more than 80% of the market value of your home on your mortgage or home equity loan combined
- Funds are disbursed in one lump sum at closing for a Home Equity Loan
- The interest rate may be a variable (HELOC) or fixed rate (Home Equity Loan)
- Interest on a Home Equity Loan is charged on the full loan amount and begins accruing on the date of closing; interest on a HELOC is only charged on the amount you borrow when you borrow it
- Interest may be tax deductible
- The money may be used for any type of expense
Using Your Home’s Equity
You’ve built equity in your home. You can put it to good use if you have credit card debt you want to consolidate, home improvements you want to make, planned or unplanned medical expenses, or to finance a big expense like college tuition. If you’ve got a steady job and are responsible with your payments, it’s a great alternative to other types of loans.
Apply For Your Home Equity Loan
When you’re ready to apply, Credit Union of Texas is ready to help! Visit our Home Equity Loan page to use our helpful calculators, check interest rates, and to begin your application. If you have questions, you can give us a call at 972-301-1880.