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What is a Home Equity Loan?

A home equity loan uses your home’s equity for a new loan using your home as collateral for a new loan. They are also referred to as a second mortgage because your home secures the loan. With a home equity loan, you can borrow up to 85% of your home’s value.

Home Equity Loan Pros and Cons


Pros

Cons

  • Pay interest only on the amount borrowed

  • Use funds however you want

  • Has a fixed interest rate

  • Write-off the interest you pay

  • Reduces the equity in your home

  • Upfront lump sum payment

  • Face foreclosure if unable to make payments

  • Closing costs between 2% - 5% of loan amount

What is a Home Equity Line of Credit?

A home equity line of credit (HELOC) is very similar to a home equity loan, however, instead of receiving a lump sum payment upfront, you are extended a revolving line of credit that you can borrow from. Unlike home equity loans, which charge interest on the full amount you borrow from day one, interest on a HELOC is only charged on the amount of money you actually borrow

HELOC Pros and Cons

Pros

Cons

  • Pay interest only on the amount borrowed

  • Lower interest rates than home equity loans

  • Pay off and borrow at any time

  • No fees when withdrawing  cash

  • Reduces your equity each time you use it

  • Has a variable rate

  • Face foreclosure if unable to make payments

  • Closing costs between 2% - 5% of the line of credit

Home Equity Loan / HELOC Requirements

  • 680 minimum credit score
  • No late payments in the last 12 months
  • Loan-to-value ratio must be 70% or lower
  • Maximum 45% debt-to-income ratio
  • Borrow up to 80% of the home’s market value

Home Equity Loan Alternatives

  • Cash-out refinancing – A cash-out refinance is similar to a home equity loan in that you’re able to convert your equity to cash. Instead of getting a second loan, you will get a new loan covering your existing mortgage plus up to 80% of your home’s value.
  • Personal loan – A personal loan is an unsecured loan up to $100,000 with a fairly short loan term of three to five years. They have higher interest rates than home equity loans, but because they aren’t secured by your home, you don’t risk foreclosure if you fail to make the payments.
  • Credit cards – A revolving line of credit will come with a high-interest rate and is best used for emergency expenses that arise. They are also unsecured.

Reasons to Get a Home Equity Loan or HELOC

Getting a home equity loan or HELOC is essentially converting your home’s equity into cash. If you use the funds for anything other than reinvesting in your home, you could end up losing everything. For example: If you have a 400k home that you owe 200k on, you get a 150k home equity loan to go on vacation and buy a boat.

What do you think happens if for any reason you cannot make your home equity loan payments? They will take your house. So it is heavily recommended that you only spend the funds from a home equity loan to make renovations to your home that will increase its value.

Using a Home Equity Loan to Repair or Renovate Your Home

Home equity loans and HELOCs should be taken out with caution. If you’re unable to repay the loan, you risk foreclosure. It’s highly recommended to use a home equity loan to make home repairs or upgrades. Reinvesting cash from an equity loan back into the home makes the most financial sense as it increases your home’s market value.

Using a Home Equity Loan for Debt Consolidation

Using your home’s equity to get a loan to repay a credit card or other types of unsecured debt is not a good idea. Credit card debt is unsecured, meaning if you don’t repay it, you won’t lose anything.

Paying off unsecured credit card debt using a home equity loan secured by your home is very risky. If you’re unable to make the payments, you could lose your home. If you are struggling with credit card debt or other types of debts, a personal loan is usually a better option for debt consolidation.