Home equity loans provide homeowners with lump sums of cash by leveraging home equity, frequently at low rates. This second mortgage product taps your equity – the difference between your home’s value and mortgage debt. This guide covers everything on home equity loans to evaluate if one suits your situation, including tax deductibility and ideal loan conditions.
What is a Home Equity Loan?
A home equity loan provides a one-time lump sum payout secured against your home as collateral. You pay back the loan in fixed monthly installments over a defined repayment term, usually between 5-30 years. The loan taps into your existing home equity – the difference between what you owe on your mortgage and current market value.
The Pros of Home Equity Loans
Used responsibly, a home equity loan can provide affordable access to your home’s cash value.
Tax Deductible Interest
By claiming home equity loans as tax deductions, households can benefit from substantial interest savings; in years where additional income places filers into higher tax brackets, maximizing home equity lines for large expenses like home renovations or college tuition may yield thousands back during tax season thanks to permissible deductions up to debts of $750,000, an intriguing tax advantage relative to other more traditional forms of financing.
Access Equity Without Selling
Tapping accrued equity in your home through cash-out refinancing furnishes funds for major financial needs without the burdens of relocating or surrendering the asset’s ownership, whether to pay emergency medical bills or remodel a kitchen; smart homeowners can prudently leverage this flexible source of liquidity during periods of rising housing valuations.
Potentially Lower Rates Than Other Loans
Contingent on households maintaining robust credit histories and profiles, home equity lending options typically levy favorable interest rates under 5% on balance transfers well below the double-digit figures associated with credit cards or unsecured personal loans, helping diligent borrowers realize significant interest savings translating to thousands of dollars over a reasonable multi-year repayment timeline.
Flexible Repayment Terms
While longer-termed home equity installments of 20-30 years ease the short-term cash flow obligations associated with this debt, opting into such lengthy commitments can amount to substantially greater interest expenses as rates remain levied over the full repayment schedule, leaving prudent households to weigh cost savings from modest monthly payments against potentially massive dollar amounts forfeited to accrued interest payments.
Risks to Consider
While useful for some borrowers, home equity loans also carry significant risks:
Closing Costs and Fees
Homeowners seeking equity must budget for expenses like origination charges, appraisals, and assorted closing fees tallying between 2-5% of the total loan value, tacking on thousands in upfront costs before even beginning months or years of interest payments, a hindrance placing home equity out of reach for cash-strapped households.
Defaulting Carries Major Consequences
Failures to satisfy home equity loan obligations expose borrowers to grave outcomes including rapidly compounded late payment penalties, outright home foreclosure initiated by lenders, and devastated credit profiles hampering future lending qualifications, all catastrophic costs making timely installments imperative, even if financially straining for households on the margin.
Strict Borrowing Limits
Extending home equity loans hinges on retaining adequate collateral asset valuation such that combined borrowing cannot operationally eclipse more than 85% of total property worth when paired with existing mortgage balances, and surprisingly failing to maintain even 20% raw equity value independently places deals out of reach, constraints demanding robust housing valuations relative to debts.
Tips for Finding the Best Loan Terms
Shopping around helps land the best rate and repayment conditions:
Compare Interest Rates and Monthly Payments
While minute fractional differences in interest rates spanning as little as one percentage point may appear negligible, the compounding effects over lengthy multi-year home equity loans can yield substantial lifecycle expense deviations equivalent to thousands in extra interest fees, making detailed rate and resulting monthly payment calculations between competitive offers an imperative buffer against preventable excessive borrowing costs.
Research Lenders’ Closing Costs
Preliminary estimates across various home equity lenders betray discrepancies as steep as several hundred dollars in upfront appraisal valuations and origination processing expenses required to activate loans, leaving cost-conscious but cash-strapped households considering such debt to prudently investigate all market options in search of the rare provider eschewing exploitation through inflated ancillary service fees layered atop already sizable interest obligations.
Ask About Hardship Options
Given life’s innate unpredictability and the long-term commitments associated with loans measured in decades, inquiring details surrounding available temporary deferments or hardship accommodations with home equity lenders provides critical insulation against destabilizing income disruptions which may undermine overall repayment capabilities, with sympathetic creditors offering key protections far exceeding the refinancing flexibilities inherent to the equity lending models themselves.
How Long Are Home Equity Loans?
Home equity loan terms typically range from 5-30 years. The most common lengths are:
● 10-year home equity loans
● 15-year home equity loans
● 20-year home equity loans
● 30-year home equity loans
A shorter duration means you pay off the loan faster and save on interest expenses. But it comes with a higher monthly payment. Opt for the shortest term you can afford each month.
Are Home Equity Loans a Good Idea for Investment Properties?
In some cases, yes. With investment property, a home equity loan can provide low-cost capital to flip houses or finance repairs and upgrades on rentals. This boosts rental profits and prepares properties for profitable resales.
Just be sure not to overleverage properties with too much equity debt. And plan to recoup the loan funds within a few years through fix-and-flip sales or higher rental income.
The Bottom Line
Ultimately, home equity lending furnishes households a flexible means to tap into accrued housing wealth for major expenses, but also exposes borrowers to risks like foreclosure. Prudent budgeting to account for closing costs, meticulous rate shopping, and conservatively limiting total debts against underlying collateral can help buyers find favorable terms within strict qualification constraints. But potential tax deductibility, preserving ownership, and favorable rates still position such products as wise solutions for some. Given the decades-long commitments required, households must scrutinize both risks and rewards through the unique lens of their financial situation to determine if tapping home equity aligns with long-term objectives before proceeding.
What credit score is needed for a home equity loan?
Most home equity lenders look for credit scores of at least 620-640 before approving loans. Borrowers with scores under 580 will likely not qualify. Those in between should expect strict terms like higher rates. Checking your credit reports and scores beforehand informs qualification likelihood, illuminates areas for improvement, and allows sufficient time to correct errors.
Can you get a home equity loan for a second home or investment property?
Yes, home equity lending products extend to secondary residences and investment properties. However, stricter qualification standards like higher credit scores and income requirements may apply. Lower maximum loan-to-value ratios limit total borrowing against the property’s value as well. Take these constraints into account when considering equity borrowing against non-primary real estate assets.
Can home equity loan payments be deducted from taxes?
If proceeds are used to substantially improve or upgrade the home itself, interest accrued on home equity loans up to $750,000 can qualify as tax deductions. This intriguing benefit makes sizable renovations, construction projects, solar panel installations, and other major home improvements sensible uses of equity loans for taxpayers.
What fees come with a home equity loan?
Like mortgages, home equity loans levy origination fees averaging 1-2% of borrowed amounts to activate the loan, alongside third-party closing/settlement costs tallying another few hundred to thousand dollars. Ongoing expenses like yearly maintenance fees apply as well. Model total costs before borrowing to avoid surprise charges.
Can you get denied for a home equity loan?
Absolutely. Failure to meet strict debt-to-income thresholds, low credit scores, or inability to retain 20%+ equity in the home independently can all prompt denials. Applying with multiple lenders helps ensure at least one approves your qualifications if equity lending remains imperative.
