One of the most significant financial benefits of being a homeowner is the ability to tap into your home’s equity. With a home equity loan, you can finance almost any project, and the borrowing costs are much lower than other loan options.
As savings balances continue to shrink due to inflation, more people are exploring home equity loans to fill the financial gaps. However, is this a smart use of your home’s equity?
In this article, we’ll look at what makes home equity loans so attractive and identify potential pitfalls to avoid.
What is Home Equity?
Home equity can best be described as the value or portion of your home that you own. To calculate your home’s equity, use the following formula:
Home Equity = Current Market Value of Home – Mortgage Balance
For example, if your home appraises for $400,000 and you still owe $250,000 on your mortgage, your home’s equity would be $150,000. As a homeowner, you could utilize a home equity loan to borrow a portion of this equity. (Each lender will have their own rules and policies on how much equity you can access).
What Makes Home Equity Loans So Popular?
It’s hard to pinpoint one aspect of home equity loans that people enjoy most because the benefits are vast. For many, it’s the combination of overall flexibility and affordability. Here are some of the key features of home equity loans that make them so attractive to homeowners:
Because home equity loans use your house as collateral, the financial risk to the lender is much lower than other borrowing options. Consequently, the interest rates charged are usually some of the lowest available.
In addition, the loan terms are significantly longer than alternatives, such as personal loans. Most home equity loan terms range between seven to ten years (some lenders extend terms up to 20 years).
The combination of a longer repayment period and lower interest rates make home equity loans extremely affordable overall.
Home equity loans are generally available in two formats: traditional home equity loan or home equity line of credit (HELOC). Your choice will come down to how you intend to use the funds.
- Home Equity Loan: A traditional home equity loan offers fixed interest rates, and the entire sum is dispersed at financing. This option is ideal if you know the cost of your project ahead of time, for example, a home remodel.
- Home Equity Line of Credit (HELOC): A HELOC is a line of credit that functions like a credit card. You can borrow from a set amount over a designated period, and the interest rates are variable. You only pay interest on the amount you borrow – not your approved line. Once you repay the balance, you can draw on the loan again.
HELOCs are great if you have several projects you want to complete over time or need quick access to low-cost funds in a financial emergency.
Depending on the value of your home and your current mortgage balance, you could have a significant amount of equity in your property. As a result, you could borrow much more with a home equity loan than alternatives, such as credit cards or personal loans. That is why home equity loans are ideal for pricey projects like home remodels.
There are generally no limits on how you can spend these funds. This feature opens a range of possibilities for borrowers. Some common uses include:
- Home repairs or remodels
- Events like weddings or vacations
- Tuition or higher education costs
- Debt consolidation
- Medical bills or healthcare-related costs
- Starting a business
- Financial lifeline for emergencies
What are the Potential Drawbacks of Home Equity Loans?
While home equity loans open many financial doors for homeowners, there are things to consider – especially regarding how you utilize these funds.
How you use the equity in your home is up to you. But it’s crucial to remember that your house is being used as collateral. What does that mean? If you’re unable to repay the loan, the lender can take ownership of your property to recoup their losses.
The last thing you want to do is potentially lose your house because you blew thousands of dollars on an impromptu vacation to Fiji. Anytime you tap into your home’s equity, you should ensure the funds will help improve your financial situation.
Home equity loans typically have terms ranging between seven to ten years. A lot can happen in that time, including career changes, spousal relationships, etc. You must ensure you can repay the debt without causing significant financial strain to you or your family should a job loss or other event occur.
Unlike traditional home equity loans, HELOCs (home equity lines of credit) often have variable interest rates (like most credit cards). That means the rates, and consequently your payment, could fluctuate over time with the economy.
We’re Here to Help!
Home equity loans are one of homeowners’ most powerful borrowing options due to their flexibility, affordability, and unlimited ways to use them. However, as your financial partner, we want to ensure you make the best financial decisions.
If you’re considering a home equity loan, we invite you to give us a call. Together, we’ll explore your financing options and determine which best matches your financial goals. To get started, please call us at 202-479-2270.