Whether you are dreaming about your much-needed home improvement project, paying for a medical procedure, or consolidating your debt to live debt-free, most homeowners need extra cash at some point in their lives to help their vision become a reality. While many homeowners need money to fund their projects, they rarely find it sitting in a savings account.
A home equity loan, sometimes called a second mortgage, is a valuable tool that offers homeowners the chance to access the equity that is already available in their home. Using this equity, homeowners get the money they need, to make the changes they want. Understanding how home equity loans work and what they can be used for may offer the insight and funding you need to achieve your financial goals faster, while saving more money, than if you were to use an alternative loan solution.
- What is a Home Equity Loan?
- How Does a Home Equity Loan Work?
- How to Calculate Home Equity
- Benefits of Using the Equity in Your Home
- Can You Use Your Home Equity Loan for Anything?
- Securing a Good Home Equity Loan Rate
- HELOC vs Home Equity Loan: What's the Difference?
- Request Loan Payment Estimates
- Pitfalls to Avoid When Applying for a Home Equity Loan
- Potential Tax Benefits of a Home Equity Loan
- Home Equity Loans with America's Credit Union
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What is a Home Equity Loan?
Home equity loans allow you to tap into the equity you have in your home in order to open your finances and life up to a whole realm of potential. Home equity loan funds can be used for anything including covering education and tuition costs, paying for home repairs, improvements or additions, consolidating debt, and substantial medical expenses.
A home equity loan is designed to be like a second mortgage. You are able to take a lump sum out of your existing equity in your home and use it for anything you like, although home improvements and debt consolidation are the most frequent uses for these funds. Using this type of loan for debt is a great option because it is already your money and you are essentially borrowing from yourself to pay off other debts that you owe. In the long run, this type of loan will allow you to get more out of your money and pay back less than you would with other options on the market.
One requirement of home equity loans is equity in your home. If you do not currently have equity in your home, unfortunately, this is not the right solution for your needs. You may want to consider a personal loan or low rate credit card instead.
How Does a Home Equity Loan Work?
When your home is valued at a higher amount than what you owe on your current mortgage, you have equity in your home. You gain equity by paying your mortgage down over time. Having equity in your home is the first step you need to accomplish before applying for a home equity loan.
When you take out a home equity loan, you will receive one lump sum payment from your equity which will need to be repaid every month for a set period of time. This is often over five to thirty years depending on the loan agreement.
In order to get this loan, you will need to fill out an online home equity loan application. During the loan application process, the loan team may review your W2 earnings statements or 1099-DIV income statements, federal tax returns, bank statements, recent paycheck stubs, and other proof of income. Your current mortgage statement and homeowner’s insurance policy declarations page will most likely be reviewed. A home appraisal may also be required. The review process is to verify you have equity in your home and you are in good financial standing to take out a loan.
When completing your online home equity loan application you will need to provide the reason you are taking the loan out, your credit information, your equity information, and possibly include the debt information that you will be consolidating. All of this information is crucial to the application process.
To dive deeper into what is a home equity loan, review our blog, “What is a Home Equity Loan and Can it Help with Debt Consolidation?”
How to Calculate Home Equity
One of the biggest components of considering if you can get a home equity loan is figuring out if you actually have the equity that you can borrow against. Home equity is the total dollar amount of your home for which you have already paid or the portion you actually own. To calculate home equity, determine the current market value of your home from a tax appraisal, realtor quote, or your best guess. Multiply this amount by 80%, then subtract the balance of your mortgage and any other liens against the property. The resulting figure is your available equity.
For example, consider a home valued at $300,000 with a $100,000 mortgage:
- $300,000 x 80% = $240,000
- $240,000 – $100,000 = $140,000 in available equity
For an in-depth look at home equity, review our blog, “What Is Home Equity? 9 Frequently Asked Questions.”
Benefits of Using the Equity in Your Home
When compared to other types of loans, such as personal or unsecured loans and credit cards, leveraging the equity in your home with a home equity loan can have lots of potential benefits including:
- Lower Rates - Home equity loans typically feature lower interest rates than other types of loan solutions.
- Predictable Payments - Unlike home equity lines of credit, home equity loans feature a fixed rate. This means your agreed-upon monthly loan payment will remain the same for the life of the loan.
- Approval - Even with shaky credit, approval for a home equity loan is still possible since lenders typically deem this type of loan as less risky because the borrower's primary residence is held as collateral.
- Large Loan Amounts - Borrowers potentially have access to large amounts of money, depending on how much equity they currently have in their homes.
- No Limits on Use - You can use the proceeds from a home equity loan to pay for anything you desire – although some reasons for taking out a home equity loan make more financial sense than others.
In spite of the benefits, it is important to carefully consider all of your options before deciding whether a home equity loan is right for you.
For a deeper understanding of home equity, review our blog, “What is Home Equity and What Can You Do With It?”
Can You Use Your Home Equity Loan for Anything?
Can you use a home equity loan for anything? Yes. Should you use a home equity loan for anything? No.
Before taking out a home equity loan, you should carefully consider the reason you want to borrow the money and whether or not the loan will improve both your current and future financial situations.
A home equity loan is a serious commitment, secured by the borrower's primary residence. For this reason, it is generally not advisable to take out a home equity loan to pay for unnecessary expenses.
Before tapping into your home's equity, carefully consider the reason you are borrowing the money and whether you truly want to commit to paying a home equity payment over the next five to thirty years. Here are some of the most common reasons people tend to utilize a home equity loan.
Can you really use a home equity loan for anything? Discover the answer in our recent blog, “Can You Use a Home Equity Loan for Anything.”
Using a home equity loan to make upgrades, renovations and home improvements rank among the most prevalent strategies. Home improvements such as new kitchens and expansive bathrooms, as well as outdoor landscape improvements such as pools, fences, and outdoor kitchens, improve quality of life and typically result in increased property value.
For more tips on using your home equity loan to remodel your home, review our blog, “Two Top Ways to Use Your Home Equity to Remodel.”
People with multiple high-interest credit cards or unsecured loans improve their financial portfolios through debt consolidation. Using a home equity loan’s lower interest rate to pay off higher interest rate debts and bring everything into one convenient monthly loan payment saves money and can shorten your repayment period. It can also help improve your credit score. If you are not seriously committed to changing your spending habits, you should think twice before using a home equity loan to consolidate debt. Your house is used as collateral for the home equity loan, so you need to be sure you can pay the loan back in the agreed-upon timeline and increments.
To learn about how a home equity loan can be used to consolidate debt, review our blog, “How Does a Home Equity Loan Work and How to Use it to Consolidate Debt.”
If you are considering using a home equity loan to get out of debt, review our blog, “How to Get Out of Debt Fast - 5 Proven Tips.”
Using a Home Equity Loan as a Debt Consolidation Loan? Avoid These Mistakes
Using a home equity loan for debt consolidation is typically a financially savvy venture. But success requires personal vigilance and financial responsibility. Be sure to avoid these common mistakes to successfully achieve your goal of financial freedom.
- Forgetting to create a budget
- Taking out a loan at a higher rate than your existing debt
- Not modifying your current spending habits
- Paying off the wrong debt first
- Closing your credit cards immediately after you pay them off
For more mistakes to avoid when using a home equity loan for debt consolidation, review our blog, “7 Mistakes to Avoid with Your Debt Consolidation Loan.”
To uncover the truth about debt consolidation and for tips to get started, review our blog, “The Truth About Debt Consolidation.”