How Long Are Home Equity Loan Terms?
Thanks to rising home values and sales prices plus tight inventories in many cities, Americans are sitting on more than $14.4 trillion in equity, according to the Federal Reserve Bank of St. Louis. Turning that equity into spendable cash with a home equity loan might make sense if you need to, say, replace an aging roof, pay off medical bills or expand a business.
This lump sum of cash is different than a home equity line of credit or HELOC, a revolving line of credit from which you draw as needed. With a home equity loan, you will make monthly payments for a certain amount of time.
How long, exactly? In this article, we compared the different types of home equity loans so you can determine a payback schedule that’s right for you or whether a personal loan might be a better fit. Read on to learn:
- What are the advantages and disadvantages of a home equity loan?
- How long do I have to pay back a home equity loan?
- Is a 5-year home equity loan term right for you?
- Why would you consider a 15-year home equity loan?
- When would a cash-out refinance be a better option?
What are the advantages and disadvantages of a home equity loan?
One big advantage: lower interest rates than personal loans or credit cards. A home equity loan is a secured loan, rather than an unsecured personal loan or a cash advance on a credit card.
|Comparing Different Loan Types|
|Type of loan||Lowest current APR*||Highest current APR*|
|5-year home equity loan||4%||5.87%|
*as of May 5, 2018
Home equity loan terms can be tailored to suit your individual needs. You can borrow for as little as five years or opt for home equity loans of 10 or even 15 years. Just as some homeowners take a 30-year mortgage and pay it off early, you can get a five-, 10- or 15-year home equity loan and make extra payments to retire the obligation sooner, unless your loan has a prepayment penalty.
Shop around for the best home equity loan terms.
Delia Fernandez, a certified financial planner in Los Alamitos, Calif., says home equity loans are fixed rate and with a set payoff schedule versus home equity lines of credit, which typically have variable interest rates. HELOC interest rates may surge or you may face an introductory interest-only payment period.
With a home equity loan, “You are paying principal plus interest on the loan, and you have an end date of success for paying off the loan,” Fernandez said.
Now for the downsides. The biggest disadvantage of a home equity loan is that the collateral is your home: Fail to make payments and you risk losing the property to foreclosure.
In addition, you’ll have to pay closing costs such as an application fee, title search, home appraisal and document preparation. These costs run between 2% and 5% of the loan total.
In the past, you could deduct interest on a home equity loan. However, the Tax Cuts and Jobs Act of 2017 suspended that deduction in most cases until 2026, unless you use a home equity loan to “buy, build or substantially improve the taxpayer’s home that secures the loan.” In other words, that new roof passes muster but using a home equity loan to pay medical bill doesn’t.
These tax changes may not affect you because the standard tax deduction has increased: $24,000 for joint filers, $18,000 for heads of household and $12,000 for everyone else. Unless your deductions are higher than that, you probably won’t itemize your taxes anyway.
How long do I have to pay back a home equity loan?
A typical term for home equity loans varies from five to 15 years. Wondering whether you have enough equity in your home to apply? Run your numbers through this home equity loan calculator.
Is a 5-year home equity loan term right for you?
The five-year loan has traditionally been the shortest home equity loan. Anything lower, says Johnna Camarillo, an assistant vice president at Virginia-based Navy Federal Credit Union, and monthly payments would be prohibitively high. The average home equity loan in Camarillo’s area is $50,000. “That’s an awful lot of money to pay back in three years,” she said.
Why would you consider a 15-year home equity loan?
Someone borrowing $100,000 or more probably can’t pay it back in five years, or perhaps even in a decade. Higher home values may justify a larger loan. In Vienna, Va., outside Washington, where NFCU has its headquarters, the median home price is $662,200 compared with the national median price of $184,700. As a result, NFCU has issued home equity loans as high as $200,000 and for as long as 20 years, Camarillo says.
Even consumers who borrow considerably less than $200,000 sometimes opt for long terms. These smaller amounts, spread out over 15 years, mean affordable monthly payments. The trade-off, however, is that each year of repayment brings additional interest charges.
“They have to weigh the difference between having that low monthly payment and how much interest they’ll have to pay over the life of the loan,” Camarillo said.
A 15-year home equity loan might be right for you if you have a big project in mind, such as adding a bedroom to your house or expanding your small business, and don’t have enough cash on hand. This loan lets you borrow a large amount of money with manageable monthly payments.
When would a cash-out refinance be a better option?
A cash-out refinance might be a better option for anyone interested in one of those longer term home equity loans. With a cash-out refi, you remortgage your home for more than you currently owe and take the difference in cash.
Here’s an example: If you owe $100,000 on a property valued at $300,000, you could refinance up to 85% of that value (which would come to $255,000) and take the difference in cash.
The advantage — as with a home equity loan — is that you get the cash in a lump sum and can use it any way you like. Depending on your use, the interest could be tax-deductible. (Again, this doesn’t matter if you take the standard deduction.)
A longer term obligation versus a five- or 10-year one makes the monthly payments more manageable. Again, though, it’s possible to make extra payments when times are good. “Or they can pay the minimum when they’re dealing with other life expenses,” Camarillo noted.
A disadvantage is that you’ll be taking out a new mortgage, so closing costs are usually higher than they would be for a home equity loan. If the current interest rate is higher than the one on your original mortgage, a cash-out refinance is not a good idea.
Should the cash-out refi leave you with less than 20% equity on the property, you might be required to add private mortgage insurance to the loan. In addition, starting from scratch with a new mortgage means you’ll likely be paying it off longer (and paying more overall) than you originally anticipated, unless you have a clear plan for early repayment.
To obtain a cash-out refi, you’ll need to meet the same qualifications for getting a new mortgage. Among other things, lenders want to see income, good-to-excellent credit, a decent amount of equity in your home and a healthy debt-to-income ratio.
A cash-out refi could be a smarter financial choice when the interest rate is lower than the original mortgage. Since each case is unique, a homeowner should run the numbers on all options “and make the best decision for their situation,” Camarillo said.
Compare the rates. Current interest rates for home equity loans range between 4% to 5.87% APR, compared with cash-out refi rates of 4.1% to 4.3% APR. Again, the interest rates are lower than personal or credit-card-based loans, because they are collateralized by your home.
The bottom line
While not without risks, home equity loans are an affordable way to fund special projects or unexpected challenges. Before tapping your equity, make a list of the pros and cons of borrowing, and make sure your budget can handle the repayment plan.