Using your home’s equity can be a great way to secure more money in a short amount of time. The cash you receive via an equity loan can be helpful for several things, such as covering renovations or as a way to pay off existing debt. However, knowing as much as possible before deciding to take a home equity loan out is essential to your financial success. If you’re considering a home equity loan, keep reading to learn everything you need to know before making the decision.
What is a Home Equity Loan?
A home equity loan, or equity loan, is commonly referred to as a second mortgage. It’s a way of borrowing money from a lender based on your home’s equity. A home’s equity is the portion of your home that you’ve already paid off. Essentially, it’s equal to the value of your home minus the amount remaining on your mortgage. As you’re borrowing against your home, the property itself is used as collateral.
For example, if your home is worth $300,000 and you still have $200,000 left to pay on your mortgage, your home equity is roughly $100,000. As you continue to pay off your mortgage, your home equity grows, and so does your wealth.
How Does a Home Equity Loan Work?
With a home equity loan, you receive a lump sum of cash that you must begin repaying immediately. It’s much like any other kind of loan and amounts typically to the value of a mortgage, hence the name second mortgage. The cash infusion happens right away, and you must start paying loan installments immediately.
Home equity loans have fixed interest rates, meaning that your payments will be the same each month. This is important when it comes to your financial planning and the repayment of the loan itself.
The Pros and Cons of Home Equity Loans
Some people see home equity loans as a risky financial decision, while others will swear by them. All in all, it depends entirely on your view of the process and the willingness to increase your debt. Regardless, there are pros and cons to home equity loans.
The Pros of Home Equity Loans
When it comes to home equity loans, there are a handful of significant pros involved. The first pro is that the loans have low, fixed interest rates. These rates are low regardless of what’s happening in the wider economy, and as such, are a better alternative to credit cards or personal loans.
Another major advantage associated with home equity loans is lower monthly payments. Because these loans have fixed interest rates and are spread out over at least ten years, the monthly payment for a home equity loan is the same every month and remains lower than any other loan.
Finally, the funds can be for anything. There are no strings attached to the money you receive from a home equity loan, meaning that you can use it however you’d like. You can use it to put yourself into a more stable financial position or improve your home.
The Cons of Home Equity Loans
With the good must come bad, and home equity loans are no different. The biggest con to a home equity loan is that your home becomes the collateral. As such, if something were to come up that would prevent you from paying the monthly loan installment, your home could be at risk. If you’re considering a home equity loan, you must make sure you can pay for it.
Another con of home equity loans is their accessibility. Home equity loans can’t be secured if you have high debt or low credit. This means that not everyone can secure a home equity loan until they’ve resolved any outstanding financial issues. If you are looking to take out an equity loan, be sure to check your credit score and start paying off debt so you can get the best rate possible.
The final con, which may be a dealbreaker, is that home equity loans come with a lump sum of cash. This isn’t the most appropriate solution for some people, and other forms of borrowing against your home may be more appropriate. Again, this depends entirely on your financial habits, but if you’d rather have a line of credit than a lump sum payment, a home equity loan isn’t for you. Instead, you might want to consider getting a home equity line of credit (HELOC).
Who Should Take Out Home Equity Loans?
If you fall into one of the following categories, a home equity loan may be right for you.
You’re Trying to Consolidate Your Debt
Home equity loans are an excellent debt consolidation tool. If you have other high-interest debts, a home equity loan may be a perfect option for you. Since home equity loans come with fixed, low interest rates, you can use the money to pay off your other debts, then make lower payments over a longer period.
You Know Exactly How Much You Need
If you’re looking to make home renovations and know the exact cost of your project, a single lump sum infusion of cash is a perfect resource. Being able to pay for an entire job in one payment can make your life easier and reduce the costs of renovations in the long run. If you have a fixed budget planned and don’t want to overspend, consider taking out a home equity loan over other financing options.
You’re in Good Financial Standing
If you have low debt and an excellent credit score, a home equity loan is the best way to secure funds with a low interest rate. These loans are only available to those with excellent financial health for a reason.
Wrapping Up
Home equity loans are an excellent option for people looking to secure a large amount of money fast. They come with low interest rates that are fixed and have no strings attached to them. They aren’t available to everyone, but if you’re eligible for a home equity loan, it’s likely going to be your best option of securing funds for any major projects.
