What is a home equity loan? What are the advantages of taking out a home equity loan? Keep reading to learn more about these questions, plus…

1. What is a home equity loan?
2. Pros and cons of a home equity loan
3. How much can you borrow?
4. Home equity loan vs. home equity line of credit (HELOC)

What is a Home Equity Loan?

So, what exactly is a home equity loan? A home equity loan is a type of loan that is secured by your home. You repay the loan with equal monthly payments over a fixed term, much like your original home mortgage. If you don’t repay the loan as you agreed, your lender can foreclose on your home. Home equity financing can be set up as either a loan or a line of credit. With a home equity loan, the lender offers the total loan amount upfront. On the other hand, a home equity credit line provides a source of funds that you can draw on as you need.

If you’re considering a home equity loan or credit line, make sure to look around and compare offers by banks, credit unions, savings and loans, and mortgage companies. You can get a better deal this way. Keep in mind that mortgage brokers don’t lend money, but they help arrange loans. Also remember that your home secures the amount that you borrow. So, if you don’t pay your debt, you may be forced to sell your home to satisfy that debt. 

A home equity loan is a lump-sum loan with a fixed interest rate, while a line of credit works like a credit card with a variable interest rate. A HELOC often requires interest-only payments during the draw period, which is usually the first 10 years. That means you’ll need to pay more than the minimum payment due to reduce the principal and make a dent in your overall debt during that time. Since the loans are secured by your house, you’re likely to get a lower rate than what you would find on a personal loan or balance transfer credit card. However, you can also lose your home if you don’t keep up with payments.

You may be considering tapping your home equity to consolidate your credit card debt, a move that can lower your interest costs but has risks. Because of these risks, NerdWallet recommends that you reserve home equity for certain circumstances.

Pros and Cons of a Home Equity Loan

Pros

• Interest rates on home equity loans and home equity lines of credit (HELOCs) are typically lower than those on credit cards.
• Interest paid on home equity loan products may be tax-deductible; credit card interest is not.

Cons

• With your house as collateral, you risk foreclosure if you can’t pay.
• If your home’s value drops, you could wind up owing more than it’s worth.
• Repayment terms can be 10 years or longer.
• The loan itself doesn’t address troublesome spending habits.
• Credit card debt is more easily discharged in bankruptcy.

Homeowners with good credit are likely to have other debt consolidation options that don’t risk their house. A homeowner with shaky finances shouldn’t move unsecured debt that can be erased in bankruptcy to secured debt that can’t.It’s debt-crushing timeSign up to link and track everything from cards to mortgages in one place.

How Much Can You Borrow?

The amount you can borrow depends on your income, credit history, and the market value of your home. Typically, the amount you can borrow is limited to around 85% of the equity in your home. When you interview lenders, ask all lenders to explain the loan plans that are available to you. Ask questions if you don’t understand something, because confusing terms and conditions could cost you more. Pay close attention to the annual percentage rate (APR) of a home equity loan, along with fees like the application or loan processing fee, origination or underwriting fee, lender or funding fee, appraisal fee, document preparation and recording fees, and broker fees. If points or other fees are added to your loan, you’ll pay more to finance them.

Always ask for your credit score! Feel free to negotiate with more than one lender. Don’t be afraid to make lenders and brokers compete for your business – you’ll get a better deal this way. Before you sign for a home equity loan, make sure to read the loan closing papers carefully. Don’t sign if you see anything that makes you feel suspicious. You can negotiate or walk away. 

Home Equity Loan vs. Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is a revolving credit line. A HELOC allows the borrower to take out money against the credit line up to a preset limit, make payments, and then take money out again.

With a home equity loan, the borrower receives the loan proceeds all at once, while a HELOC allows a borrower to tap into the line as needed. The line of credit remains open until its term ends. Since the amount borrowed can change, the borrower’s minimum payments can also change, depending on the credit line’s usage.

Key Differences

HELOCs can be useful as a home improvement loan since they allow you the flexibility to borrow as much or as little as you need. If it turns out that you need more money, you can get it from your line of credit-assuming there’s still availability—without having to re-apply for another mortgage loan.

One question you should ask yourself: What’s the purpose of the loan? A home equity loan is a good choice if you know exactly how much you need to borrow and how the money will be used. Once approved, you’re guaranteed a certain amount, which you receive in full when the loan is advanced. , as a result, home equity loans can help with big expenses such as paying for a children’s college fund, remodeling, or debt consolidation.

Conversely, a HELOC is a good choice if you aren’t sure how much you’ll need to borrow or when you need it. Generally, it gives you ongoing access to cash for a set period—sometimes up to 10 years. You can borrow against your line, repay it all or in part, and then borrow that money again later, as long as you’re still in the HELOC’s draw period.

However, an equity line of credit is revocable—just like a credit card. If your financial situation worsens or your home’s market value declines, your lender could decide to lower your credit line or close it altogether. So while the idea behind a HELOC is that you can draw upon the funds as you need them, your ability to access that money isn’t a sure thing.

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