So, you’ve owned your house for several years now and are starting to think about how you can get the most out of your investment. Home equity loans make it possible to use your investment to cover the costs of a big project or other expense. Find out how.
What is a Home Equity Loan?
A Home Equity loan is essentially a loan that uses your house as collateral. To figure out how much equity you have, simply subtract what you owe on your mortgage from the value of your house. Equity can increase as the value of a home increases and/or as the mortgage balance decreases.
Depending on the amount of equity available, banks will allow homeowners to access it through a loan. Home equity loans are appealing because they’re typically available at lower interest rates than many other types of loans, such as credit cards or unsecured loans. However, since the loan is structured to use your home as collateral, defaulting on the loan could lead to foreclosure. That’s why it’s important to only pursue a home equity loan if you’re sure that you can make the payments.
What’s the Difference Between a Home Equity Term Loan vs. Line of Credit?
The difference between a home equity term loan and line of credit comes down to the means in which it is distributed. A home equity term loan is a loan in which the borrower gets a one-time lump sum. The loan is repaid over a fixed term, at a fixed interest rate, with equal monthly payments. Interest rates on home equity loans are typically a little lower than they are for a home equity line of credit.
Conversely, a home equity line of credit is a kind of revolving credit that allows you to borrow money as you need it with your home as collateral. You can usually spend the funds however you want (up to the credit limit) using special checks or a transfer to a checking account.
Most home equity lines of credit allow you to draw funds over a set amount of time known as the draw period. At the end of this period, you may be able to renew the credit line and keep withdrawing money. Some home equity lines of credit require you to pay back the entire amount at the end of the draw period, whereas some allow you to make payments over another time period known as the repayment period. Interest rates on a home equity line of credit are typically variable and require only interest payments during the draw period.
When Are Term Loans or Lines of Credit Most Appropriate?
Term loans are typically used if the borrower already knows exactly how much they need to borrow—like if they have a contractor’s estimate for a renovation project, for example. A home equity line of credit is more appropriate for uses where the borrower doesn’t know exactly how much money they need or when they will need it.
Because term loans are more predictable (due to the fixed rate and regular payment schedule), they’re generally easier to pay off. However, a line of credit provides a level of flexibility that can be really important in an emergency situation—such as an unexpected and urgent home repair or medical expenses.
How are Home Equity Loans Calculated?
Most banks can lend up to 80% of the value of the home minus whatever the mortgage balance is. For example, if your home is worth $200,000, but you owe $100,000 on the home, the maximum amount the bank can offer for your home equity loan is $60,000.
That’s because 80% of $200,000 is $160,000. That $160,000 minus $100,000 equals $60,000.
How Long Does it Take to Pay Off a Home Equity Loan?
The payment plan for most home equity loans are no longer than 20 years—typically less, depending on the specific case.
Are There Lots of Fees for Home Equity Loans?
Unlike a mortgage, a lot of the process can be handled within the bank itself and doesn’t typically require the borrower to pay many closing costs. For example, while a mortgage requires an in-person appraisal that could cost the borrower close to $500, most home equity loans can be calculated based on the appraised value identified by a digital database.
Can a Home Equity Term Loan be Used to Pay Off a Mortgage?
Yes. Depending on how much you still owe on the home, your banker may be able to help you refinance your home in conjunction with your home equity loan and cut several years off of your remaining payments.
If you’re wondering if a home equity loan is right for you, you can always reach out to your local Union Community Bank to find the answers you need. By consulting with a banker, you’ll get the best understanding of your unique situation and determine the specific risks and benefits that would be associated with your loan. So, if you’ve been thinking that it might be time to take on that big renovation project or pay off your home early, now could be a great time to pursue it—before interest rates go up.