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Home Equity Loan Basics

Home Equity Loans

You may have the option to borrow against a portion of the available Glossary Term: equity in your home if the remaining Glossary Term: principal you owe on your home is only a portion of its current value. For example, if you’ve been paying down the principal balance on your mortgage or the value of your home appreciates, you may be able to tap into a portion of your accumulated equity. Two popular options for doing this are taking out a home equity loan or a home equity line of credit.

Here, we’ll talk about home equity loans.

What is a home equity loan?

A home equity loan is secured by your home and enables you to access a portion of your available equity in the form of a single payout and a fixed interest rate with fixed monthly payments. Unlike a home equity line of credit (HELOC), your home equity loan proceeds are paid out as a one-time lump sum, and you can’t borrow funds on the loan again, even if you repay them.

Understanding the basics

Here are some basic things to know about home equity loans:

The rate. A home equity loan features a fixed Glossary Term: interest rate, which means your monthly payments will be fixed. This payment stability can make it easier to budget around this type of loan. As an added bonus, the interest paid on a home equity loan is usually tax deductible, so you could potentially save on the interest you pay. (Everyone’s situation is different, so you should talk to your tax advisor regarding interest deductibility for your personal situation.)
Qualifying. In order to qualify for a home equity loan, you must have available equity in your home. In other words, the amount you owe on your home must be less than the value of your home. Most lenders will allow you to borrow up to 85% of the value of your home minus the amount you owe. Your lender will also typically look at your Glossary Term: credit score and history, employment history, monthly income, and monthly debts, just like they did when you first got your mortgage.

 

Maximum loan amount. Your lender will calculate the maximum loan amount you can borrow. Here is an example of the calculation:

Assuming the lender allows a maximum loan amount of up to 85% of your home's value and your home appraises for $300,000, if you owe $150,000 on your current mortgage you may qualify for a loan amount of up to $105,000. ($300,000 x 85%= $255,000 - $150,000 = $105,000)

The home equity loan checklist

While many lenders offer the same features in their home equity loans, some features will vary. Comparing these points as you shop could make a difference in your payments:

  • Cancellation/early payoff fee: Fee charged if the loans is closed before a certain date (if less than 3 to 5 years from the date opened, it could cost from $500 to $1,000).
  • Minimum loan amount: The minimum amount a lender requires you to borrow.
  • Up-front fees: Some fees are charged by the lender to set up your home equity loan like application/and or appraisal fees.
  • Automatic payment discount: Discounted interest rate offered by some lenders if you establish automatic payments from an account also held by that lender.

 

Is a home equity loan right for you?

A home equity loan could be a good option if you have an immediate expense and want to receive all of your funds up-front and/or you prefer to always pay your loan in fixed payments over a fixed period of time. For some borrowers, payment stability over the life of the loan can make it easier to set and manage a budget.

So before you get a home equity loan, consider things like whether a fixed-rate loan suits your needs, how much you think you’ll need to borrow over what period of time, and whether you’ll be able to make the payments in full and on time in order to maintain your credit rating and keep your homeownership secure. Since your house is used as Glossary Term: collateral for your home equity loan, it’s important not to fall behind in your payments and put your home at risk.

When borrowing from a home equity loan, mortgage, credit card or any other credit product, it’s important to borrow only the amount that you can comfortably afford.