We’ve often heard of many benefits to owning a home whether it may be tax benefits, gaining market value, or even just planting roots somewhere and starting a new life. One of the most important benefits, however, is building equity and borrowing against it in the form of home equity loans.
Equity is the difference between what your home is worth today and what you owe on your mortgage. Let’s say you still owe $200,000 on your mortgage and your home is currently worth $300,000; this means you have $100,000 worth of equity. To qualify for a home equity loan, you’ll need to have built up enough equity in your home first.
Home equity loans are second mortgage loans that you pay off with monthly payments, just like a primary mortgage. When you apply, you are likely to be approved for a portion of your equity, not the entire amount. Once you’re approved, you’ll receive your money in a single lump payment and pay the loan back with interest over a set period of years. Your monthly payment will vary and is dependent on the amount borrowed along with your interest rate.
You can use the money from these loans for anything you want. Using this money for the right reasons can be a smart and efficient way to borrow money. The critical catch is being smart about it. Like everything in life, there are pros and cons to home equity loans.
- Home equity loans usually come with a lower interest rate than personal loans.
- The loan is received in a lump sum which allows for immediate use.
- Fixed interest rates make budgeting easier
- You are not limited on what you can use it for
- If you use the loan on home improvement, tax deductions are available on the interest
- Your home acts as collateral
- If you spend your loan money recklessly and cannot pay it back, your lender could take your home through the foreclosure process
- Adds to your monthly debt which postpones saving towards retirement accounts
These loans are popular because the opportunities with the cash are endless. If you’re in a pinch and need college tuition money for your kids, you can use a home equity loan for this. Are looking to remodel your home and put some upgrades in the kitchen or backyard? It’s a great option for that too! If you have racked up debt on a credit card with ridiculously high-interest rates, swapping out that debt for home equity debt with lower interest rates makes perfect sense.
Getting approved for a home equity loan is very similar to primary mortgage approvals. A general rule of thumb is the higher the credit score, the lower the interest rate.
Approval will vary by lender, but they will typically look at three things:
- Minimum credit score of 620
- Debt-to-income ratio of 43% or lower
- Maintain at least 15-20% equity in your home
Ultimately, home equity loans are a great way to utilize the equity you’ve gained in your home to alleviate possible stressors or roadblocks in the future. They are also a savvy way to reinvest in your home and gain even more equity by funding home improvement projects. The important takeaway here is to be smart with your money and make sure it’s propelling you further ahead.