How do home equity loans working? – In times of high inflation, stock market volatility, and bank failure, many Americans are looking for ways to finance their expenses, pay off high-interest debt, and, generally speaking, make ends meet. Common solutions they use might include credit cards and personal loans. But homeowners shouldn’t neglect one of their best sources of financing: the equity in their home.
There are several ways homeowners can leverage their home equity, including with a reverse mortgage, cash-out refinancing, home equity lines of credit (HELOCs), and home equity loans. Home equity loans, in particular, can be a cost-effective way to access funds for home repairs, renovations, and other purposes.
But how exactly do home equity loans work, and when does it make sense to get one? That’s what we’ll explore below.
Check your home equity loan options here to see if a home equity loan is right for you.
How do home equity loans work?
A home equity loan acts as a second mortgage. This allows you to borrow a certain amount of money based on how much equity you currently have in your home. You pay back this amount over a period of time (usually five to 30 years) at a fixed rate of interest.
Your home’s equity is determined by subtracting your outstanding mortgage balance from the current market value of your home. The higher your home’s value, the more equity you have.
For example, you bought a house for $300,000. You make a payment of $50,000, bringing your balance down to $250,000. If your home was still worth $300,000 when you applied for a home equity loan, your equity would be $50,000 ($300,000 minus $250,000). But if the value of your home increases to $400,000, your home equity will be $150,000 ($400,000 minus $250,000).
Lenders usually let you borrow about 80% of your home equity. So if your equity is $50,000, you can probably borrow $40,000 from a friend. If you wait until the price of your house reaches $400,000, you may be able to borrow $120,000. Taking a home equity loan when home values are high allows you to maximize your loan amount. That said, regardless of the value of your home, a home equity loan may still be a better route than other financing options.
If you think you could benefit from a home equity loan, start exploring your options here.
Are home equity loans worth it?
A home equity loan can be worth it for many reasons. Here are three that stand out.
- Low interest rates: Home equity loans are guaranteed by your home, so the risk is lower for the lender. This security often means lenders offer lower interest rates on home equity loans than you would receive for other financing options, such as credit cards. The specific interest rate you receive depends on factors like your credit score and income. (Here are some quick tips to improve your credit.)
- Fixed rate: Helocs often have variable interest rates, meaning your payments can fluctuate from month to month. Home equity loans typically offer a flat rate for the term of the loan, giving you a set monthly payment to budget for and protecting you from rising interest rates.
- Interest is tax deductible: If you are using your home equity loan proceeds for an IRS-approved purpose, you may be able to deduct interest on your tax return. “Interest on home equity loans and lines of credit is deductible only if the loan funds are used to purchase, build, or substantially repair the taxpayer’s home, guaranteeing the loan,” the IRS explains. “Loans must be secured by the main house or second home of the taxpayer (qualified residence) and meet other requirements.” Consult a tax professional if you are unsure whether you qualify for this deduction.
Underline
If you’re a home owner, leveraging your home’s equity can be a great way to finance everything, from major purchases to paying down debt. If you use the funds to build or make significant repairs to your home, you may even qualify for a tax deduction.
Remember to shop around to find the best home equity loans. Compare your options and apply when home values are high. You can also take steps to build your equity quickly to increase how much the lender can give you.