Why Is a Home Equity Loan a Good Idea?
Your home is your most valuable possession, but it’s more than a place to live and an important investment for the future. The equity you’re already building in your property is a real asset, one you can borrow against to help pay for home improvements and upgrades, a college upgrade, or anything else you want.
In this blog we take a look at how a home equity loan works, what makes it such a useful financing tool, and when borrowing using a home equity loan can be a good idea. Read on to learn how the equity you already own in your home can help you build a better future.
HOME EQUITY LOANS: PUT YOUR HOUSE TO WORK
A home equity loan lets you borrow against the portion of your home you have already paid off while continuing to pay down the remainder of your mortgage. It’s a great way to access the cash you’ve already invested in your home without having to sell your house. Here’s how it works:
Your equity is the difference between the market value of your home and the remaining balance on your mortgage. If you made a substantial down payment, have been making payments for some time, or if the value of your home has increased since you bought it, then you likely own a fair amount of equity in your home.
How Home Equity Loans Work
A home equity loan essentially piggybacks on your home loan, even if it’s not from the same lender, allowing you to access the cash you’ve already paid on your mortgage and to repay it while continuing to build your equity by paying down your original mortgage.
Home equity loans are available from banks, credit unions, and other lenders. Typically, you need to own at least 20% of your home’s value to take out a home equity loan. Lenders usually allow you to borrow up to 80% of the value of your home, depending on your income, creditworthiness, and, of course, how much of your home’s value you own as equity.
Home equity loans also operate a lot like actual mortgages. You’ll need to prove that you have a stable income and a reasonable credit score to get approved. You’ll also need to show a reasonable debt-to-income ratio for all your borrowing.
BENEFITS OF HOME LOANS
Home equity loans come with some big advantages over other ways of borrowing cash. Here are just a few of the benefits.
1. Low Rates
Because home equity loans are secured by your property in the same way your mortgage is, rates are typically lower than unsecured forms of borrowing, such as credit cards, personal loans, and unsecured lines of credit. That makes home equity loans one of the most affordable ways to borrow for major expenses.
2. Higher Borrowing Limits
Depending on the amount of equity you hold in your home, a home equity loan can potentially allow you to borrow far more at one time than you would with many other forms of borrowing.
3. Lump Sum Payout
Even better, you get the money you borrow under a home equity loan as a single lump sum payment. That’s money you can choose to invest, save, or spend as you wish.
4. Longer Repayment Terms
Home equity loans also offer longer repayment terms — sometimes up to 20 years — than other forms of borrowing, allowing you to spread the load of major expenses over a significant period. That can be useful, especially if you reinvest the money in your home.
5. Predictable Payments
Home equity loans are also typically fixed-rate loans, meaning you’ll pay the same annual percentage rate (APR) for the life of the loan. You’ll know exactly how much you need to come up with over the life of your loan from the start, as well as how much you need to pay on your monthly payments.
6. Tax Deductibility
The interest you pay on your home equity loan is also tax deductible in some circumstances, specifically when you use the loan to fund qualifying improvements to the home you are residing in. This makes using a home loan for upgrades to the home you borrow against one of the most efficient ways to borrow money and put your equity to work.
7. Credit Score Improvement
A home equity loan counts as a major installment loan. As such, applying for and getting approved for a home equity loan may temporarily drop your score, over time, making on-time repayments will improve your payment record as well as your overall credit mix. Together these factors can have a significantly positive effect on your credit score.
POTENTIAL DRAWBACKS
Taking out a home equity loan is a major financial step, so it’s important to also consider some potential drawbacks before making your decision. Here are some things to be aware of.
- Evaluating Risk: Consider carefully how much risk you are prepared to shoulder by taking out a second mortgage on your home. You will need to repay both loans over a significant period.
- Wise Uses: Although you are free to use the cash from a home equity loan in any way you please, there are smarter ways to use it than others. The best use is for major expenses that improve either your assets or your ability to earn money in the future.
- Reduced Equity: By borrowing against your equity you are reducing the amount of equity you hold in your home. While ideally, your home will increase in value, you’ll need to start from scratch building back the amount of equity you choose to borrow.
- Borrowing Against Your Home: Most importantly, a home equity loan uses your home as collateral in the same way your mortgage does. If your financial situation changes and you are unable to repay either loan, you risk losing your home altogether.
WHEN IS A HOME EQUITY LOAN A GOOD IDEA?
So, what can you use a home equity loan for? Home equity loans make the most sense when you need to finance a major expense over a long period of time. This is because there are costs associated with acquiring a loan that would make it uneconomical to apply for smaller amounts.
Once in place, however, your home equity loan puts a large lump sum in your pocket that you can repay at a relatively low interest rate over a long period.
That said, because you are dipping into a valuable and hard-earned asset — your home equity — it makes sense to spend your money on an investment that will improve your long-term financial stability.
Common uses for home equity loans include:
- Renovations that put the money back into your home
- Upgrades or a downpayment on a second property
- A college or graduate degree
- Specialized equipment
- Essential medical care
- To consolidate major, high-interest debt
Many people also use home loans to help pay for important family events like weddings, landmark birthdays, and reunions, or to pay for a dream vacation. This is feasible when you have a workable, affordable plan to rebuild your equity over time.
WHEN IS A HOME EQUITY LOAN NOT A GOOD IDEA?
Conversely, home equity loans are not ideal for funding smaller purchases, for impulsive or unnecessary spending, or paying items that lose value quickly, including:
- New or used vehicles, or vehicle upgrades
- Luxury items
- Furniture or clothing
- Loans to friends or family
- Speculative investments
- Daily expenses
- Home improvements that do not add long-term value
ALTERNATIVE TO HOME LOANS
Home equity loans are hard to beat if you need to access a significant lump sum at a reasonable rate, but there are alternative ways to borrow money, depending on how much you need and your ability to repay.
- Credit cards are a convenient option for short-term borrowing of smaller amounts but come with significantly higher interest rates.
- Personal loans have higher interest rates than home equity loans but are cheaper and easier to qualify.
- Home equity lines of credit (HELOCs) allow you to tap into your equity as you need it but require discipline to use responsibly.
- Cash-out refinancing involves refinancing your existing mortgage for more than you owe and taking the difference for cash, effectively liquidating your equity.
NEXTMARK: YOUR HOME EQUITY LOAN EXPERTS
You’ve worked hard to build equity in your home. Now let your home equity work hard for you with a home equity loan from NextMark Credit Union.
Apply now, or talk to us about your specific borrowing needs. We offer innovative, flexible loans designed to get you the money you need to get ahead in life
- Low payments based on up to 40 year amortization
- Competitive fixed Annual Percentage Rate
- Combined loan-to-value up to 100%
Contact us today, or click below to find out how NextMark can help your home equity open more doors for you.