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Home Equity Loans 101 – Everything You Need to Know

Dekoven Wesley


If you're a homeowner, chances are you've heard of home equity loans. But what are they, exactly, and how do they work? In this post, we'll cover everything you need to know about home equity loans, including the risks, benefits, and alternative options. Let's jump in! 

What are Home Equity Loans 

A home equity loan is a type of loan that permits you to borrow funds using your home as collateral. The amount you can borrow is based on your home's equity, which is the difference between the market value of your home and the remaining amount you owe on the loan. 

Home equity loans usually come with fixed interest rates, which means that the interest rate stays the same throughout the life of the loan. A fixed interest rate benefits borrowers who prefer a predictable monthly payment—in other words, you can expect to owe the same each month, making budgeting simpler.  

Home equity loans frequently come with lower interest rates than other loan types, making them attractive options for homeowners who need to borrow a significant amount of money. 

How Does a Home Equity Loan Work? 

Wondering how to get your money? Here are the details: when you take out a home equity loan, you get a lump sum of money, which you repay over a set period. The loan is secured by your home, which means that if you cannot make the payments you have committed to, the lender can foreclose on—or take—your home.  

The exact amount you can receive with a home equity loan ultimately depends on a number of factors, including your home's value, mortgage balance, and credit score. Lenders typically will allow you to borrow up to 80% or 90% of your home's equity.  

For instance, if your home is valued at $500,000 and you still owe $250,000 on your mortgage, your home equity would be $250,000. If your lender allows you to borrow a maximum of 80% of your home's equity, you could be eligible for up to $200,000.  

Is it Easy to Get Approved for a Home Equity Loan? 

The approval process for home equity loans is similar to many other types of loans. It typically involves a credit check, an appraisal of your home's value, and other financial assessments, depending on the lender's requirements. 

home equity loans 101, everything you need to know

How Can You Use a Home Equity Loan? 

The money you receive from a home equity loan can be used for many purposes, including: 

  • Home improvements  

  • Property renovations 

  • Debt consolidation 

  • Paying medical bills 

  • Education expenses 

  • Other emergencies 

Pro Tip: One of the more exciting benefits of a home equity loan is that the interest is tax-deductible if you use funds from the loan to improve your home. 

What are the Risks of a Home Equity Loan? 

The most significant risk of a home equity loan is that you are putting your home up as collateral. You could lose your home if you cannot make your loan payments.  

Home equity loans can also be risky if you use them to consolidate debt. If you cannot keep up with your loan payments, you could end up in even more debt than you had initially. 

Plus, many homeowners aren't aware of the additional expenses owed when they sign on to a home equity loan. Costly fees (including closing costs, appraisal fees, and application fees) can all add up very quickly. These extra costs make a more significant impact if the homeowner is on a budget with little savings left.  

Having access to a large sum of money can be tempting, but if you borrow more than you can realistically afford to repay, you could end up in a tricky cycle of debt.  

Keep in mind that your credit score may initially drop when taking out a home equity loan—just as it might when taking out a loan for a vehicle or property. However, like those same instances, your credit score quickly increases as you pay off the debt promptly. A home equity loan will not permanently damage your credit score. 

home equity loans, alternate options

Alternate Options to a Home Equity Loan 

If you're not comfortable with the risks of a home equity loan, here are three alternatives you can consider: 

  1. Personal Loans 

  2. Cash-out Refinancing 

  3. HELOCs 

Personal Loans 

Personal bank loans are unsecured loans that borrowers can use in a variety of ways, such as funding a vacation or covering medical expenses. Unlike secured loans, personal loans don't require collateral, making them a convenient choice for borrowers who don't want to put their assets at risk.  

However, due to a lack of collateral, personal loans will generally have much higher interest rates than secured loans. It's important to note that personal loans have a fixed repayment period, and the interest rate and monthly payment amount are decided based on the borrower's creditworthiness. 

Cash-Out Refinancing 

Cash-out refinancing is when you substitute your existing mortgage with a new one with a higher balance. You can then use the difference between your old and new mortgage balances to get cash. However, this option can be more expensive than a home equity loan because you will need to pay closing costs on your new mortgage. 

HELOCs 

A home equity line of credit (HELOC) is a type of revolving credit that allows you to continually borrow funds up to a specified limit. You can borrow and repay as needed, and you only pay interest on the amount you borrow. However, HELOCs commonly have variable interest rates that can increase over time. 

The contrast between a home equity loan and a home equity line of credit (HELOC) is that a home equity loan is a one-time loan with a fixed interest rate, while a HELOC is a revolving line with a variable interest rate. A home equity loan might be better for one specific considerable expense, while a HELOC might be better for ongoing access to funds over a more extended period of time. 

home equity loans expert

Mortgage & Loan Experts at Your Service 

A home equity loan is a valuable tool for homeowners who need access to cash. However, it's crucial to weigh the risks carefully before you decide to take out this type of loan.  

If you need help determining whether a home equity loan is right for you, an experienced loan officer can help you make a smart decision. 

Are you ready to transform your home equity into cold, hard cash? For help deciding which loan option is best for your circumstances, click here to contact the mortgage professionals at The Mortgage Minds Group. 

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