A home equity loan, often called a home equity installment loan or second mortgage, allows homeowners to borrow against the value of their property that is not mortgaged. Securing the loan with your home's value offers several benefits, making it a versatile option for various financial needs.

Understanding Home Equity

A home equity loan lets you borrow money based on your home's value. You can borrow up to the difference between your home's current market value and the outstanding balance on your mortgage. Most home equity loans have fixed rates, ensuring consistent payments throughout the loan's duration.

Overview of Home Equity Loans

A home equity loan functions similarly to a mortgage. You use your home's equity—the value not covered by a mortgage—as collateral to secure the loan from the lender. Typically, you can borrow up to 80 to 90 percent of your home's total value.

For example, if you own a home appraised at $200,000, you can determine how much equity you have in the home by subtracting the current balance on your mortgage. Let's say you owe $150,000 on your home loan. That means you have $50,000 worth of equity. You can borrow up to 90% of the home's value, up to $180,000 in total, combining the mortgage you already have and the new home equity loan. That means you may be eligible to borrow up to $30,000 for any needs, depending on your eligibility.

You will have a set period to repay the loan, much like your current mortgage. Most are shorter terms than a mortgage, but you can work with this through the lender to find a level that fits your needs.

Also notable, the interest rate on a home equity loan tends to be lower than unsecured loans. That means if you borrow that $30,000 on a credit card, you could pay twice as much or even more based on the interest rate.

Applying for a Home Equity Loan

Like obtaining a mortgage, borrowers must show lenders they have the financial means to repay the loan. To do that, you will fill out a loan application providing your name, contact information, income and employment verification, and references. The lender will consider many factors to determine if you qualify, including your credit history and whether you make payments on time with your current lender.

You do not have to obtain the loan from the same lender you currently have your mortgage with. It can be beneficial to shop around to determine which lender best suits your needs (with the lowest interest rate and borrowing ability.) Each lender also sets qualification requirements, which include:

• How much you can borrow
• The credit score you need to have
• What your monthly payment may be
• The length of the loan
• Whether it is a fixed rate or an adjustable rate loan

Apply after comparing your options to ensure you are getting the best opportunity to borrow funds affordably.

Pros and Cons of Home Equity Loans

With any financial instrument, you must consider the pros and cons.

The benefits of home equity loans typically include:

• These loans can be an easy-to-obtain source of money that you can use for any needs, including home improvement, debt consolidation, or even making a down payment on another home.
• The interest rates are much lower than what you may pay on an unsecured loan. However, this is dependent on your credit qualification. The interest rate is likely higher than the existing mortgage loan, though.

The disadvantages of home equity loans include:

• If you borrow through a home equity loan up to the value of your home, and the market drops, you could owe more on the home equity loan than your home is worth.
• If you default on the loan, the lender may seek to foreclose on the home to repay the loan.

Best Practices When Considering a Home Equity Loan

To ensure you're making the right decision about using a home equity loan, consider the following:

• If you are using it to improve your home, be sure it adds value. That way, you are putting that equity back into your home.
• When using the loan for debt consolidation, know the risks and avoid using your unsecured debt again, or you could be in twice the debt.
• Shop around before choosing a loan or lender. You have options to consider, including various types of lenders, including banks, specialized lenders, and credit unions.

Takeaways

A home equity loan is a financial tool that allows you to make the best use of your home's value when it comes to borrowing. Like any loan, you must be sure you responsibly use the funds and select the most affordable loan for your needs.