When it comes to loans, it can be hard to decide which loan option is right for you. For homeowners hoping to consolidate debt or looking to explore other ways to borrow money, home equity loans are a common option.
As the housing market recovered, Americans borrowed $21 billion annually on average against their homes from 2012 through 2015, according to USA Today. Although Americans might not be borrowing at the same rate as before, home equity loans are still a go-to option for people in need of some major cash. Keep reading to find out what exactly a home equity loan is, its pros, cons and how it differs from a home equity line of credit.
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What Is a Home Equity Loan?
A home equity loan is a type of loan that essentially serves as a second mortgage. It allows you to borrow a fixed amount of money over a fixed term as you would with a normal mortgage, according to the Federal Trade Commission. The difference here is that you borrow money against your home’s equity. Thus, in the event that you have trouble making payments on the loan or you default, your home serves as collateral to satisfy the remaining debt. Home equity loans are not available to renters.
Reasons People Take Out Home Equity Loans
Here are some common reasons people take out a home equity loan:
Extensive remodeling or large home repairs can be costly, so many people opt to take out a home equity loan to cover these expenses. But be sure that any changes or additions you make add to the overall value of your home. For example, if you deck out your kitchen with modern appliances, you could potentially increase the sale price of your home by 3 to 7 percent.
Because the interest rate on a home equity loan is much lower than those for credit cards and other loans, many people use the home equity loan to consolidate and pay off previous debts since it can save them money on interest costs. This can, in turn, help you pay off your debts much sooner.
Pay for Education
It’s no secret that education is expensive, especially higher education. The average price of tuition and fees for a student to attend a four-year university for one year ranges from $9,410 to more than $30,000, according to College Board. Multiply that figure by four years, and education costs can easily reach over $100,000 for one student.
Pros of Home Equity Loans
If you’re considering a home equity loan, weigh the pros and cons against other options to decide if it’s the best way to borrow for your situation. Here are some of the perks of home equity loans:
Home Equity Loan Interest Rates Are Usually Low
Because the risk for a lender is lower — since repayment of the loan is secured through the collateral of your home — interest rates are typically lower than those of unsecured loans.
Unlike credit cards, which usually come with variable APRs, home equity loans have fixed-interest rates available, which translates to fixed monthly payments.
Home equity loans are generally tax deductible but according to a new advisory issued by the IRS, “the Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
Cons of Home Equity Loans
Although home equity loans might seem like a sweet deal if you’re in need of a large sum of money, there a few things to watch out for:
Costs and Fees
Home equity loans typically have closing costs that total 2 to 5 percent of the loan amount. The fees usually include: “attorney or title company representative fees, a title search, document preparation, an application fee, and an appraisal to evaluate the market value of your property,” according to Lending Tree.
Home Equity Loan vs. Home Equity Line of Credit
A home equity line of credit differs from a home equity loan in that it operates more like a credit card. You draw the funds as you need them, as opposed to receiving the entire loan amount up front. So, you’ll only need to pay back whatever amount you choose to borrow.
|Differences Between Home Equity Loan vs HELOC|
|Home Equity Loan||HELOC|
|Fixed-interest rate||Variable interest rate|
|Make payments on entire loan amount||Make payments on the amount you actually borrow|
|Receive large sum of money at once||Borrow as much as you need at any time|
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