From paying down those credit cards to making a major purchase, like a new car, a home equity loan could be a reliable source of funds. But because you’re borrowing against your home, you should know what exactly you’re getting into. Here is a look at the basics of home equity loans to help you ask yourself, “Is a home equity loan right for me?”
What is a home equity loan?
With a home equity loan, you borrow against the equity you have built up in your house. Put simply, equity is the value of your house minus what you owe on it. So, if your house could sell for $160,000, and you owe $100,000, you have $60,000 in equity. The total amount you can borrow is based on the loan-to-value ratio (the ratio of any loans using your house as collateral to the value of the house) allowed by your lender.
Home Equity Loan Example (This example is for demonstration purposes only.)
If your house could sell for $160,000, you owe $100,000, and the loan-to-value ratio allowed by the terms of your loan is 80%, you could borrow up to $28,000. Here is the math:
| Market value of home | $160,000 |
| Mortgage balance | $100,000 |
| Loan-to-value ratio set by lender (LTV) | 80% |
| Percentage of market value = Market value x LTV | $128,000 = $160,000 x 0.80 |
| Maximum home equity loan amount = percentage of market value - mortgage balance |
$28,000 = $128,000 - $100,000 |
Whatever you borrow with a home equity loan, you get in one lump sum and pay it back over the term of the loan (usually 2 to 15 years).*
A home equity line of credit is like a home equity loan in that you borrow against the equity you have built up in your home. This revolving loan will allow you to make large purchases, pay them off, and maintain your equity credit line for the next purchase, like a credit card.
Is it right for you?
You can use the funds from this kind of loan to pay for a variety of expenses. Some customers use them to:
- Pay off credit card debts with higher interest rates than their home equity loan
- Make home improvements
- Make a large purchase such as a car
To determine if a home equity loan is a right for you, ask yourself the following questions:
- How is your credit? Borrowers generally have to have excellent credit scores in order to take out a home equity loan. Learn more about credit scores.
- How is the market? Check out comparable homes in your area, or consult a realtor®. If homes like yours are selling for more than you owe, it might be the right time. Lately, real estate prices have been high, so your home could be worth more than you originally thought.
- If you’re planning to make a home improvement, will your purchase increase the value of your house? Upgrades like new kitchens or bathrooms almost always add value, but cosmetic changes don’t necessarily make a house more attractive to buyers. You might consider talking to a realtor before you borrow.
- If you recently got a mortgage or decided to refinance, check, and see if there is a waiting period before you can borrow more money against your home.
Home equity loans offer additional benefits that could make them an attractive option for you:
- The interest paid on home equity loans is tax deductible.
- Interest rates for home equity loans are typically lower than rates on credit cards and other consumer loans.
Financial considerations
Finally, before you take out a loan, take some time to evaluate your finances and decide how much you can afford in loan payments. If you cannot pay your home equity loan back, you might be forced to sell your house. You certainly want to make sure you are comfortable with the added payment in combination with your overall financial picture. Our loan officer can help you determine acceptable debt-to-income ratios, although the payment needs to be comfortable for you and your family.
Learn more about home equity loans or home equity lines of credit, or contact us at 402-292-8000.
*See the rates page for full disclosures.
