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By: AgFed Credit Union

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When Does a Home Equity Loan Make Financial Sense?

 Mar 21, 2024
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As a homeowner, you possess a unique financial advantage – the ability to build and utilize the equity in your property. Home equity loans offer an affordable means to finance a wide range of expenses, including home renovations, weddings, and higher education.

Nevertheless, some homeowners are hesitant to access their home’s equity. Often, people are unsure how these loans work and their potential benefits. Others aren’t positive whether a home equity loan is the best solution for their financial needs.

Before highlighting the best ways to use home equity loans, it’s helpful, to begin with the basics.

What is a Home Equity Loan?

A home equity loan allows you to access a portion of the equity in your property. You can calculate your home’s equity by subtracting the amount you owe on your home from its current market value.

Home Equity = Market Value of Home – Amount Owed (Mortgage Balance)

For example, if your home appraises for $350,000 and you still owe $200,000 on your mortgage, your home equity would be $150,000. You can use a home equity loan to access a portion of these funds.

There are three key benefits to home equity loans:

  • Lower Interest Rates: Since your home is used as collateral for the loan, the interest rates are typically much lower than alternatives, such as credit cards or personal loans.
  • Flexible Terms: The loan terms can extend up to 10 years or more, helping to keep your monthly payments affordable.
  • Higher Borrowing Limits: Most homeowners can borrow significantly more money through a home equity loan than credit cards or personal loans.   

Types of Home Equity Loans:

There are two types of home equity loans:

  • Home Equity Loan: A traditional home equity loan provides you with the borrowed funds upfront in a lump sum. The interest rate is typically fixed, meaning it will not change over the life of your loan. These loans are best for one-time projects, such as home renovations, debt consolidation, or paying for an event like a wedding.
  • Home Equity Line of Credit (HELOC): A HELOC functions similarly to a credit card. You will be approved for a specific credit limit that you can borrow from as needed. When you repay the balance, the funds are available to use again. HELOCs generally have variable interest rates, meaning they can fluctuate over time with the economy. These loans are ideal when you have several ongoing projects or want peace of mind knowing you can access funds whenever needed.

When is it Ideal to Use a Home Equity Loan?

Now that you understand how home equity loans work and the various types, let’s dive into the best way to use these financial tools.

Word of Caution:

While there are no rules on how you can spend this money, you don’t want to spend it frivolously. Your home is used as collateral with home equity loans, meaning if you cannot repay the loan, the lender could foreclose on your property to recoup their losses.

This fact scares many potential borrowers away from accessing their home’s equity. However, if you plan to use the money responsibly, these loans can be financial lifesavers due to the lower interest rates, flexible terms, and higher borrowing limits.

Realizing that your home will be used as collateral, there are two main categories for using home equity loans: building equity and financing tools.

  • Building Equity:

Using the equity in your home to generate even more equity is an excellent idea. Homeowners often accomplish this through home renovations. Whether repairs or remodels, using your existing equity to improve your living space and add more value to your home can be a win-win.

  • Financing Tools:

Another popular way homeowners use their home’s equity is to finance projects, events, or improve their financial situation. These lower-rate loans provide affordable solutions for just about any cause, including:

  • Debt Consolidation
  • Milestone Events (e.g., a wedding)
  • Medical Expenses
  • Higher Education
  • Financial Lifeline

However, you must use these funds responsibly. While it can be tempting to use some funds to jet off to a tropical paradise for a few weeks, it’s probably not worth risking your home.

How to Use a Home Equity Loan Responsibly:

Again, home equity loans provide a slew of financial perks to homeowners. The ability to borrow low-cost funds with extended payment terms is financially significant. However, you also want to avoid risking your property due to improper spending.

Before you apply for a home equity loan or borrow from your existing HELOC, ask yourself a series of questions:

  • Why am I borrowing this money? Will it improve your financial situation? Will it add value to your home?
  • Can I comfortably repay this loan? Do you have a secure job and a consistent monthly income? Is the monthly payment affordable?
  • Is this the ideal option? Can you obtain the funds in a more affordable manner elsewhere, such as an emergency fund or savings account?

Taking a moment to review your options is a crucial step to ensure responsible borrowing and spending.

We’re Here to Help!

The ability to tap into your home’s equity is a significant financial benefit for homeowners. When used responsibly, these loans provide an affordable means to tackle projects of all sizes.

If you have questions about home equity loans or want to see how much equity you have in your property, we’re ready to help. Please give us a call to speak with a team member today.

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