What Can I Do with a Home Equity Loan?
Basically, a home equity loan is going to give you a big lump of cash, and you can do any of three things with it: You can take care of an emergency; you can buy something fun; or you can use it to make money. If you’re looking at a loan to pay for an emergency, then you already know how you’re spending your money. Here are some examples of common ways people use home equity for fun, for profit, or both:
- Buy a vacation home, retirement home, or timeshare.
- Buy a boat, RV, or other grown-up toys.
- Renovate that terrible kitchen/bathroom/patio that you just can’t look at anymore.
- Add luxury to your home, such as an outdoor kitchen, a pool house, or a garage apartment.
- Start that small business you’ve been toying with.
- Take some time off to work on your novel/screenplay.
- Purchase a rental property. Maybe that vacation home or retirement home can pay for itself.
- With the low interest rate on first mortgages and home equity loans, many investment portfolios will simply pay you more than your interest rate.
What is a Home Equity Loan?
Home equity loans can be confusing at first.
Equity: Your equity is the amount of your home that you own (the amount that is paid for on your mortgage compared to the appraised market value of that same house). Remember, your home is probably not worth the same amount you paid for it, and any profit belongs to you. On the flip side, if your home has decreased in value since you bought it, that means you have less equity available.
Collateral: When you take out any loan, the lender wants to know they’ll get their money back. Collateral is something you own that the lender can take if you default on your loan. When you borrow against your home equity, you are using your home as collateral.
Types of Home Equity Borrowing
Home Equity Loan: Commonly referred to as a second mortgage, this is the most common form of turning your home equity into usable cash. Usually, the second mortgage is on a fixed and shorter term than the first, although some can last up to 15 years. People usually choose home equity loans when they want a large lump sum of cash.
Home Equity Line of Credit: Unlike home equity loans, which tend to be repaid at a fixed rate for a set amount of time, like a car loan, HELOCs are set up more like a credit card, with a revolving line of credit for smaller purchases that might change every month.
Loan or Line of Credit?
A home equity loan and a home equity line of credit (HELOC) sound very similar, and the process of applying for both is similar, too.
A second mortgage is a loan that’s secured by the value of your home when you still have a first mortgage. If you need a large, fixed amount of money for repairs or other expenses, taking out a second mortgage can allow you to pay for them at a favorable interest rate. This is an option for major planned purchases or for expensive emergencies.
A home equity line of credit is like having a credit card that’s secured by your home. Like a credit card, there is a credit limit. In a home equity loan, the limit is usually pegged to the value of your house and what is still owed on the first mortgage at the time of opening the account. It’s good for a specific term, called a “draw period,” which is generally 10 to 15 years. In many cases, the interest on a HELOC is tax-deductible, but you should confirm that with your trusted tax preparation professional.
If you want a large chunk of money right now, you need a home equity loan. If you need small amounts of money over time, consider a home equity line of credit.
Usually, when you make a shopping decision, you have a pretty good idea how two products differ. With second mortgages, you don’t get the advantage of experience and you don’t have commercials helping you make the decision. It’s also difficult to see how the products differ from one another without doing a lot of math.
- Loan minimum: This is the smallest sum the institution will lend on a home equity loan. If you want less than the minimum, consider a HELOC.
- Loan maximum : This is the largest sum the institution will lend, and it’s usually set at a percentage of your home’s equity.
- Fixed-rate vs. adjustable rate: Just like your first mortgage, your second may have a fixed or adjustable rate, depending on the lender and product. With a HELOC, you can usually only find adjustable rate mortgages, which means your interest rate will change each time the Fed raises or lowers interest rates, though usually not by a significant amount.
- Draw period: The amount of time on which you can draw from your equity, specifically for HELOCs. A draw period is usually between 10 and 15 years.
Moving Beyond the Numbers
There are a variety of other factors to consider when you pick your lender.
- Do you have a relationship with this lender?
- How has their customer service been?
- Are they easy to reach by phone, by email or in person?
- Ask your friends and neighbors about anyone they borrowed from.
- Did you hear positive or negative reviews?
- It’s important not to get swept away by flashy websites or impressive advertising. You’re going to be working with your lender for a long time and you want to be confident that you can trust them.
It’s important to assemble a team of professionals you trust, to make sure you get the best deal and set yourself up for financial success. For many people, the team they assemble for their second mortgage is comprised of the same professionals they use every day, like their lawyer and accountant. You also might want to include a mortgage specialist. The mortgage specialist or mortgage consultant knows all the intricate details of lending regulations in your area, and they’ve seen enough second mortgages to know how to best handle your loan, especially if any special problems arise. Mortgage consultants can also help you set your budget, so you don’t incur more debt than you’re comfortable with or less than you need to accomplish your goals.