Home equity loan: find out the best way to spend it

Sometimes, you can borrow money using your real estate as collateral. Did you know about this type of loan? Understand everything about home equity loans and how to use it to your advantage. 

What is a home equity loan? 

To get a personal loan you need a good credit score and income that will determine how much the bank can give you and over how many months you can pay. But there’s a different type of loan that allows you to give the lender a collateral and get money against it, such a home equity loan. 

Equity is the keyword here: it’s the difference between your home’s value and how much you owe in mortgages. The less you owe, the higher the equity meaning lenders allow for bigger loans. 

what is a home equity loan
Hand presenting model house for home loan campaign

This also means that you can get better equity by paying off your mortgage. Those who live in places where real estate value went up recently go through the same process.  

Your home is a collateral, what does it mean?

Yes, you’re putting your home on the line to get a loan. When you decide to use it as a collateral, lenders can get the property when you fail to finish paying. It might sound risky, but home equity loans are pretty common in the financial market. 

Whenever you finance your home or get a second mortgage you’re involved in a type of home equity loan. However, be careful when you decide to take this type of loan. If you aren’t sure about your financial health and think there’s a possibility of being unable to pay, that might not be the safer choice. 

Even using a home as a collateral no one is assured of getting a loan. There are other costs involved, such as fees and taxes, that could keep you from achieving this. 

Is a home equity loan risky?

When someone says you could lose your home through a home equity loan anyone gets scared. Is it so risky you shouldn’t even consider it? As with everything in finance, not exactly. As long as you have a real idea of your budget and lend responsibly, it’s a great way of getting money with lower interest rates. 

Home equity as collateral is only risky for those who are looking for quick money without plans for payment. Always remember that a loan is a long term relationship you’ll live with for months or even years. You must be prepared to set money aside for that. 

Home equity loan vs. home equity line of credit

There is a second option that uses your house or property as a collateral: home equity line of credit, also known as HELOC. It is a simple adjustable loan that works like a credit card, you might even receive one upon making this kind of deal. 

HELOC pre-approves a credit limit and withdrawal limit for transactions. After you use this credit, you’ll need to make monthly payments that correspond to the limit used and the interest rates, a lot like you pay a conventional credit card. 

Most cases have credit approved for up to 10 years with payment for 10 to 20 years. 

How does a home equity loan work? 

Once the deal is made you’ll get access to all the money at once. That’s why we talked about a budget before, if you already know how much you have to spend and where, it can help to keep everything under control. 

Repayment happens monthly composed of two parts: principal (part of the amount borrowed) and interest rates. When you start your budget be sure to consider this extra monthly obligation. To keep your financial health up to date, you have to be able to afford the payment and other fixed expenses. 

How much can you borrow?

The answer depends a lot on how much your real estate property is worth. Most loans allow from 80% to 85% of this value, subtracting your mortgage debts. If you’re considering this type of loan, do a simple mathematical account and you’ll be able to know how much you can get out of it. 

Home equity loan requirements

Each lender has their own requirements for a home equity loan, but most of them include: 

  • 15% to 20% minimum home equity; 
  • At least 620 credit score;
  • Low debt-to-income ratio, meaning 43% or lower. 

Often your home is worth more or less than what you bought it for. That’s why some lenders also require an appraisal of the property before considering you approved for the service. 

Advantages of a home equity loan

For consumers a home equity loan means an easy and fast cash source. Another advantage of getting this type of loan are the low interest rates, which are much lower than most options in the market, such as personal loans. Just be aware that the rates aren’t lower than your typical mortgage. 

One interest fact is that a home equity loan tends to have much lower interest than credit cards. Which makes it the ideal source of money for debts such as these, but we’ll explain more about this particular use of a loan later. 

This happens because using a real estate property for collateral is a lenders’ dream. They get to collect interest rates on mortgages and later on home equity loans. Even though many consumers have far from perfect credit scores, it isn’t considered high risk, since defaulting on payment means repossessing the property and selling it once again. 

Understand the three day cancellation rule

Are you regretting your home equity loan? There is a federal government law that allows consumers to cancel their loan. That is, as long as they decide within three business days of closing the deal. 

If you decide to cancel you don’t need a strong reason, actually you can do so for anything as long as you use your main residence as collateral. Even having second thoughts on the matters is reason enough to give up on the loan. 

Anyone that decides to cancel must mail or hand in a written notice before midnight of the third business day. Phone calls, e-mails or even face to face conversation aren’t options for this, so be sure to send your notice properly. 

Uses for a home equity loan

Considering you’re putting your home on the line for a home equity loan, it’s important to make all the right decisions. There are many reasons that lead people to take out this type of borrowed money, but a New York Times’ research identified the four main ones and when they are a good idea. Find out more below!

1. Home renovation

This is, by far, the leading reason for taking out a loan and it makes all sense. Renovations are usually budgeted expenses, which means you know exactly how much you’ll need and how long you need to pay it back. 

Home improvements are necessary to keep your house habitable and also helps to improve its market value. At least that happens when you’re preparing to rent it, which will become revenue in the future, so a great idea overall. 

One great plus for house renovation is that this loan is tax deductible when it substantially improves the home that was used as collateral. The low interest rates also make everything simpler, way better than using a credit card or other types of loans for renovations. 

2. Paying other debts

Are you getting lost in many types of debts, such as personal loans and credit cards? Getting a home equity loan is a solution that many Americans use wisely. When you pay off your remaining debt with this loan you trade a lot of different payments for a single monthly one with much lower interest rates. 

Using this strategy many people manage to finish paying debts with less overall interest. This can help with: 

  • Credit cards;
  • Student loans; 
  • Personal loans;
  • Other types of debt. 

After you finish paying all you owe, the monthly payment drops considerably. 

3. Making investments

People looking for financial stability might also decide to take out this type of loan. Not only does it allow you to better your credit score by keeping a varied financial portfolio, it also helps you invest further. 

Real estate is the main choice of investment for people who took out home equity loans. After getting the money, you can buy your second home, vacation home or real estate to rent out and make a profit. But it’s important to plan ahead, since these investments can take a while to actually bring returns. 

You might also feels tempted to invest in the stock market, a much riskier choice. Since the returns aren’t 100% guaranteed you could end up losing the loan and end up with a lot of debt on your hands.

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