When you’re looking for a way to cover an unexpected expense, put on a home addition, or for virtually any other purpose, a home equity loan could be exactly what you need.
The loan itself is based on the value of your home. Often called a second mortgage, the amount you can borrow is based on a relatively simple calculation. A common home equity loan amount is 80% loan-to-value. That means you can borrow 80% of your home’s equity.
Here’s an example you could use for understanding the financial ins and outs of taking out an equity loan. Let’s say your home is worth $200,000. You still owe $110,000 on your home so you have $90,000 in equity. 80 percent of that equity value is $72,000. Here’s how you get that number.
When you get the loan, you receive a check for that $72,000 in a lump sum. When you do get the money, the loan repayment schedule starts right away. Most home equity loans have repayment periods of from 5 to 15 years, but 5 years is the most common loan term.
One of the reason lenders like these loans is because you have put up your home as collateral. You can use the money from the loan for almost anything but you must make sure you pay it back; otherwise, you risk losing your home.
Taking out an equity loan is considered a one-time event. That means you still have your regular mortgage payment to make. There’s no need to worry about this, it’s just something you need to remember.
Like any financial instrument, home equity loans come with pros and cons. You have to take a look at both of these to make sure a home equity line of credit is what you need.
• Interest rates are usually fixed, not variable. This means your payment is always going to be the same. You made a contract to pay back a certain amount of money in fixed payments. This means it is much easier to plan for in your home budget.
• Lower cost of borrowing. This means a home equity loan is going to cost you less in interest than a personal loan or borrowing cash against your credit card. Of course, you must be sure of the interest rate before you sign the loan documents, but typically these loans cost far less in interest.
• You get the money in the form of a check all at once. You don’t need to wait for the loan to be doled out in installments; you get the money in a lump sum. This means you can immediately deposit the loan proceeds check and use the money right away.
• No limits on what you can use the money for. You can use it for expenses, college education, a long-awaited vacation or even home improvements. The money is in your control and you can use it how you want.
• Losing your home. In this type of loan, you are putting your home up as collateral. This doesn’t mean if you’re late on a single loan payment that you’re going to lose your home. It does mean that you can risk losing your home if you don’t make good on paying back your loan.
• Going underwater with your payments. The value of real estate properties fluctuate. If you find yourself with a home that is worth less than when you took out the loan, you could owe more on your home than it is actually worth. This is commonly called being upside down or underwater. It doesn’t happen so much anymore since the rules were changed following the 2008 loan crisis, but it’s still a possibility.
• Fees. With any loan, there are closing costs and fees. You must pay those otherwise you can’t get the loan. Before you commit to taking out a loan, you must know how much in costs and fees you are going to have to pay.
Taking out an equity loan can be a great way for you to cover large expenses or even go on a great vacation. It does come with some risk but many borrowers have found that the value of getting the money they need far outweighs the risks involved.