Using a home equity loan can actually save you money. Whether you are considering renovating your home, buying a car or a variety of other goals, a home equity loan can help you accomplish your objective while saving you money.
When getting a loan of any type, you have to pay interest. Interest is the cost for borrowing the money. It can add up quickly, so it is better to pay as little interest at possible. Using a home to get a loan is one of the cheapest ways to borrow money. The interest rates on a credit card or personal loan are much higher than with a mortgage or home equity loan. Also, the interest on loans secured with a home is tax deductible.
A home equity loan borrows money from the equity in your house. The equity is the part of your home that you actually own. You can build equity in your home in two ways: one, through paying more to the principal and, two, through the appreciation of your home’s value. When you sell your house, the home equity is the cash that you get. Using a home equity loan is a means to access that cash while still living in your home.
There are two types of home equity loans available to you. The first is simply called a home equity loan. It is similar to a first mortgage in that you receive a lump sum and the interest and principal payments combine to pay off the loan within a specific number of years. Home equity loans are usually for a 15-year term and carry a slightly higher interest rate than a first mortgage.
Another option is called a home equity line of credit (HELOC). With this type of loan, you access the money as needed through special checks tied to the loan. HELOCs have adjustable interest rates, and you only pay interest on the amount you withdraw rather than the entire credit limit. The line of credit is typically extended for a 10- or 20-year term. After that, there is a fixed period in which you must pay off the remainder of the loan and interest.
The equity in your home can be a great financing option for you. Perhaps you need to add an addition to your house, or to renovate your kitchen. Or, maybe you need to consolidate your debt from several high interest credit cards. You may even want to use your home equity to buy a car. Instead of paying the high interest rates of a car loan, you can get a lower rate and have tax-deductible interest if you use your home equity. If you need the money for a one-time purpose, such as consolidating debt or buying a car, a home equity loan is usually the more appropriate choice. For a home renovation, however, HELOCs are generally the better alternative. You can borrow the money only as you need it.
An important fact to remember with both a home equity loan and a HELOC is that you reduce the equity in your home until you repay the debt. So let’s say you bought your house for $200,000 and sell it for $250,000. You also have a home equity loan for $20,000. Instead of having $50,000 of equity at closing, you only have the difference between your profit and the balance of your home equity loan: $30,000.
One note of caution with any type of home equity loan: the collateral is the house. That means, if you default on the loan for some reason, you can lose your home. Before getting a home equity loan, be very sure that you can afford the monthly payments.