Home equity loans allow homeowners to borrow a large amount of money relatively easily and cheaply. But they are not the right option for all situations. Here's a bit more about how they work and when a home equity loan may be the right choice for you.

 

How Home Equity Loans Work

A home equity loan is a loan secured by the value of your house. They come in two basic varieties: 

• A Fixed Home Equity Loan is a fixed payment installment loan, sometimes called a second mortgage.

• A Home Equity Line of Credit (HELOC) functions much like a credit card with a variable rate and changes in the monthly payment.

Home equity loans come with favorable terms because they are a low risk for lenders. To qualify, you will need significant equity in your home — that's the difference between what your home is worth and what you owe on it.

 

For example, if your house is worth $250,000 and your mortgage balance is $150,000, you may have $100,000 in equity. Lenders will allow you to borrow some of that equity but usually not all of it. Lenders use a figure called loan-to-value ratio, or LTV, to help determine the amount of loan for which applicants qualify. When considering a home equity loan, your LTV is the amount you currently own on the house, plus the amount of the home equity loan divided by the home’s current value. Using the example above, if you were to borrow $50,000, your LTV would be 80% [(150,000+50,000)/250,000]. The lower the LTV, the easier it is to quality for a home equity loan.

 

PROS

Home equity loans have a number of advantages over personal loans and some other kinds of debt:

 

They typically have lower interest rates.

They can be easier to qualify for, even if you have average credit.

Interest payments may be tax-deductible.*

They offer higher loan amounts, depending on the home equity available.

 

CONS

There are also some downsides to home equity loans:

 

If you miss payments on your loan, the lender can foreclose on your home.

If your home value drops, you could end up with a high LTV, or even “underwater” on your mortgage, and owe more than the home is worth. If this happens, and you were to sell your home, you would owe your lender the difference between the sale price and your mortgage at closing.

 

How to Use a Home Equity Loan
 

Because home equity loans can provide a large amount of money, borrowers tend to use them to pay major expenses, such as:
 

• College tuition.

• Large medical bills.

• Home improvements or major repairs.

• To fund a wedding.

• Refinancing high-interest debt
 

Many factors should impact your decision about taking out a home equity loan, including the state of the real-estate market in your area and whether you have better ways to raise money. Talk with an Advantage Financial representative for more information.

 

Most importantly, make sure a home equity loan suits your long-term goals, as well as your more immediate needs.

 

*Consult your tax advisor.

 

© Copyright 2017 NerdWallet, Inc. All Rights Reserved