What to Know About Home Equity Loans

If you’re a homeowner, you have a powerful tool in your financial arsenal—the home equity loan.

Home equity loans allow some consumers to borrow a large amount of money relatively easily and cheaply. But they aren’t right for all situations. Here’s a bit more about how they work and when they’re a good option.

How Home Equity Loans Work

A home equity loan is a loan secured by the value of the borrower’s house. Sometimes called second mortgages, home equity loans come with favorable terms because they’re low risk for lenders. To qualify for one, you’ll need significant equity in your home — that’s the difference between what your home is worth and what you owe on it.

Lenders use a figure called loan-to-value ratio, or LTV, to help determine which loan applicants qualify. For example, if your house is worth $250,000 and your mortgage balance is $150,000, you have $100,000 in equity. Your LTV, which is the amount you currently owe on the house divided by its current value, is 60%. The lower the LTV on your first mortgage, the easier it is to qualify for a second.

Keep in mind that a home equity loan is different from a home equity line of credit, also called a HELOC. Home equity loans are installment loans with fixed payments, like auto loans; HELOCs are revolving debt with variable payments, like credit cards.

Pros and Cons

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

  • They typically have lower interest rates
  • They’re easier to qualify for, even if you have average credit
  • They offer potentially high loan amounts, depending on the home equity available

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 high LTV or even “underwater” on your mortgage, owing more than the home is worth. And if 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

Some homeowners use home equity loans to consolidate higher-interest debt, such as credit card debt. However, that’s considered a risky move by consumer groups like the Consumer Financial Protection Bureau, since failing to make payments on a second mortgage can lead to foreclosure.

Many factors should inform 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 a representative at your local credit union or financial institution for more information.

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

Content provided courtesy of NerdWallet.

 

Federally Insured by NCUA. Equal Housing Lender

 

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Extra Credit provides general information to help improve our Member’s financial lives. Every situation is different, so please contact us for guidance on your specific needs. The advice provided in Extra Credit is not intended to serve as a substitute for speaking to a loan representative, financial advisor, or BALANCE counselor who can help tailor a solution for you.

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2 thoughts on “What to Know About Home Equity Loans

  1. There is a lot that you need to take into consideration before deciding on whether or not you want a home equity loan. However, I do like that the article brings up the fact that they usually have lower interest rates. That can be a real big selling point for a lot of people that might be looking to get one after all.

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