Discover the benefits and risks of home equity loans and if they’re right for you. Read on to learn more.
Homeownership comes with many benefits. For some homeowners, it’s the embodiment of the American Dream –– the result of years or even decades of hard work and strategic saving. Homeownership also means the freedom of getting to make changes to your home as you see fit, creating the home you’ve dreamed of over time. But when you become a homeowner, you also build equity over time, making homeownership a solid investment in addition to the benefits listed above (and the countless others we haven’t even mentioned.)
But while home equity can be a great asset, most homeowners don’t realize their investment gains until they sell their home –– at which point all that home’s equity is typically rolled into the purchase of the next house. Through various financial tools, however, homeowners can tap into this equity without selling their home, using home equity to accomplish any number of personal and financial goals. Home equity loans have recently surged in popularity among American homeowners, reaching levels not seen since 2010.1 But what is a home equity loan? And is a home equity loan a good idea? Explore the benefits of this tool and some home equity loan risks to help you make the right decision.
Also known as a second mortgage, a home equity loan allows homeowners to borrow against the equity they have built up in their property. In this second mortgage, borrowers receive a lump sum payment, which is determined by factors like credit score, debt-to-income ratio, and the amount of available equity. With their home’s equity, homeowners can invest in stocks or finance business ventures, take care of hefty home maintenance bills, and even establish college funds. But any amount borrowed must be paid back with interest, meaning this money is far from free.
Home equity loans are secured by the property itself, meaning failure to make regular, on-time payments can result in the home’s foreclosure –– so borrowers should know precisely what they’re signing up for before pursuing this option.
There are several situations where taking out a home equity loan can be a viable option. From home improvements to investments, the reasoning will depend on what your overall financial goals are.
One popular reason for taking out a home equity loan is to finance home improvement projects. Seeing as renovations can increase your home's value, using a home equity loan to remodel allows you to leverage the equity you have built up in your property to fund these improvements.
For homeowners with high-interest debt like credit card debt or student loan balances, consolidating them with a home equity loan can be a smart move. By paying off high-interest debt with a lower-interest home equity loan, you can potentially save thousands on interest payments while simplifying your debt management.
Should an investment opportunity arise, like starting a business or getting in on a promising stock, home equity loans can help free up capital. Some may see this as gambling with home equity, but others have found success by putting their home equity line to work for them.
Unforeseen financial emergencies can arise, and a home equity loan can provide funding in times of need. Whether it's unexpected medical bills or necessary home repairs, having access to a home equity loan can provide the financial flexibility required to eliminate some of this financial burden and avoid defaulting on other loans.
Home equity loans offer advantages to homeowners, allowing them to leverage hard-earned equity now rather than waiting until their home has sold. But they also come with some downsides that are worth considering.
As mentioned above, because home equity loans use your property as collateral, defaulting on the loan could result in foreclosure. This is perhaps the biggest risk of a home equity loan, as a homeowner using equity to reinvest in their property could lose the property altogether for failing to service the loan. Before entering into a home equity loan agreement, it is essential to have a thorough understanding of both your financial situation and your potential obligation, ensuring you’re able to make timely payments for as long as the next 30 years.2
Homeowners should also note that taking on a home equity loan means adding a new debt obligation on top of your existing mortgage. This is why home equity loans are often called “second mortgages,” and the amount needed to service the loan each month can easily equal the cost of your mortgage –– depending on loan terms and interest rates.
Much like a first mortgage, a second mortgage comes with closing costs, origination fees, and even appraisal fees in some cases. These expenses add up, with closing costs averaging between two and six percent of the total loan amount.3 On a $100,000 home equity loan, this can be an extra $2,000 to $6,000, so you must factor these fees into your decision-making process.
After weighing both the pros and cons of a home equity loan, you might be considering if this financial tool is right for you –– and if there’s room in your budget for the monthly payment. Determining the monthly payment on a home equity loan involves several factors, including the loan amount, interest rate, and repayment term. For this example, let’s look at a $50,000 home equity loan with a fixed interest rate of 7.85% (US Bank’s current average fixed APR) and a repayment term of 10 years.
Using US Bank’s online loan calculator, we can estimate the monthly cost to service a loan with these terms. In this example, the monthly payment comes out to $602. While that may seem feasible to some borrowers, consider that this comes out to over $20,000 in interest over a 10-year period. Further, these figures were calculated using an excellent credit score and high home equity share and will likely vary depending on the terms and conditions of the loan.4
Short answer? It depends! deciding if it is a good idea to take equity out of your house boils down to your individual circumstances and financial goals. Below are some factors to consider when deciding if a home equity loan is right for you:
Home equity loans can be beneficial when used responsibly –– for home improvements or consolidating high-interest debt. If you have a clear plan for the funds and can achieve a positive financial outcome using a home equity loan, taking equity out of your house might be a good idea.
Home equity loans often have lower interest rates compared to other forms of borrowing, including credit card debt and personal loan options. Further, these interest rates are typically fixed, compared to the variable interest rates found in other equity products (like HELOCs.) If you can secure a favorable interest rate and the loan’s cost is less than its potential benefits, taking equity out of your house could be advantageous.
Before considering a home equity loan, assess your financial stability. Do you have a steady income, emergency savings, and a budget that accommodates the additional monthly payments? Taking equity out of your house should be a tool –– not a limiter –– and should not jeopardize your financial well-being or put you at risk of defaulting on your existing loans.
Deciding whether a home equity loan is a good idea requires careful consideration of your financial situation, goals, and the potential risks and benefits involved. While a home equity loan can offer opportunities for leveraging the equity in your home, it’s far from the only way to access home equity –– and tools like Truehold’s sale-leaseback can help you tap into this equity without the risk of foreclosure or the additional debt burden.
With our sale-leaseback, homeowners sell their homes to Truehold in exchange for their home equity. Then, they can continue living in the home while paying rent, using the equity to consolidate debt, make future-focused investments, or simply enjoy their favorite things in life.
Offering many of the benefits of a home equity loan without any of the risks, more and more Americans are choosing Truehold’s sale-leaseback to tap into their home equity. Reach out today to learn more!
Sources:
1. Bankrate. Home Equity Loans on the rise in 2023. https://www.bankrate.com/home-equity/why-borrowers-keep-leveraging-equity/
2. LendingTree. How Long Are Home Equity Loan Terms? https://www.lendingtree.com/home/home-equity/how-long-are-home-equity-loan-terms/
3. Rocket Mortgage. A Guide to Home Equity Loan Closing Costs. https://www.rocketmortgage.com/learn/home-equity-loan-closing-costs
4. US Bank. Home Equity Rate and Payment Calculator. https://www.usbank.com/home-loans/home-equity/home-equity-rate-and-payment-calculator.html
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