Should You Get A Home Equity Loan

With how quickly the market and home values have climbed in Utah, many homeowners have a lot of equity in their home. Equity is the difference between your home’s current appraised value and your mortgage balance. If your home appraises for $400,000 and you owe $200,000, your equity is 50 percent or $200,000.

So, for homeowners who need cash, a home equity loan can be a smart choice. It’s generally faster, easier, and less expensive than a cash-out refinance, and it doesn’t restart the clock on paying off your home.

It also has these pros and cons:

Pros:

• Lower fixed interest rates. Compared to other forms of borrowing, home equity loans generally have a lower interest rate no matter what is happening in the economy. Home equity loans often have closing costs and appraisal fees, which you may be able to roll into your loan. When considering offers from different lenders, make sure you’re comparing the total cost of each loan by looking at the annual percentage rate. APR includes both the loan’s interest rate and its fees. Some lenders offer home equity loans with no closing costs or fees while still offering competitive interest rates.

• Lower monthly payments. Your credit score, other debts, and home equity loan amount will determine your interest rate. Relatively low interest rates plus repayment periods of 10 to 30 years can mean affordable monthly payments.

That said, the more years you take to repay your loan, the more interest you’ll pay. Consider these examples:¹

10-year home equity loan

Amount borrowed: $30,000

Interest rate: 6 percent

Monthly payment: $333

Total interest: $9,967

30-year home equity loan

Amount borrowed: $30,000

Interest rate: 6 percent

Monthly payment: $180

Total interest: $34,751 

• Proceeds can be used for any purpose. It is up to you how you use the equity you take out of your home. You can use it to consolidate debt, pay tuition, medical expenses, or even to buy a new investment property!

Cons:

• Your home secures the loan, so your home is at risk.

Foreclosure is possible if you can’t make your payments. You’ll want to carefully choose a loan amount, term, and interest rate that will let you comfortably repay the loan in good times and bad.

Still, even though your home secures the loan, lenders usually don’t want to foreclose. Foreclosure is expensive and doesn’t guarantee that the lender will recoup what you owe, especially if you’re carrying more mortgage debt than your home is worth. This can happen when homes lose value in a declining market. 

When borrowers have payment trouble, some lenders are willing to work with them to modify or restructure a home equity loan. But you shouldn’t count on it, and you should know the worst-case scenario.

• You have to borrow a lump sum.

With a home equity line of credit, you can borrow smaller amounts as you need them and only pay interest on the money you truly need to borrow. With a home equity loan, you must choose a lump sum to borrow all at once and pay interest on the full amount.

This aspect of home equity loans isn’t always a drawback. Let’s say you’re a homeowner building an addition to your house or remodeling your kitchen. You’ll know at the outset what your contractor is going to charge, and you can even add a cushion for potential overages. If you don’t spend it all, you can use the funds for something else or repay them early. But you should still borrow carefully.

• You can’t get a home equity loan with too much debt or poor credit.

The thing about borrowing against your home is that it doesn’t work as an option of last resort. As with any loan, the lender wants to know you’ll be able to repay it. Just like when you took out your primary mortgage, you’ll typically need a credit score of at least 620, a debt-to-income ratio generally no higher than 36 percent to 43 percent depending upon the lender, and a steady income. Some lenders have higher credit score requirements and lower debt requirements. 

While relatively cheap, a home equity loan can lengthen the time until you own your home free and clear and, if things go south, put you at risk of losing your home. Weigh the pros and cons of home equity loans carefully, then get offers from several home equity lenders to see what your options are. If you need help finding an amazing lender, I’ve worked with quite a few and can help you out.