Nicki & Karen

What Are The Advantages of a Home Equity Loan?

Nicki & Karen » May 1, 2022

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Being a homeowner comes with many tangible benefits that include everything from tax advantages to more privacy. Among the top benefits of owning a home is that you will be able to build equity, which is the difference between the value of your home and the amount you still owe on your mortgage. If your home is valued at $300,000 but you only owe $150,000, this indicates that you have upwards of $150,000 in equity.

If you decide to sell your home at some point in the future, you would likely be able to obtain a sizable portion of your initial investment since a majority of the loan would have already been paid off. Another option at your disposal is to apply for a home equity loan, which gives you the opportunity to tap into the equity that you’ve built up over the years.

A home equity loan is essentially a form of debt that you take on with characteristics that are very similar to those of a standard mortgage. The main difference between a mortgage and a home equity loan is that the home equity loan will give you direct access to a certain amount of cash. The amount of cash that you qualify for depends on the amount of equity you’ve built up.

If you opt for a home equity loan, you will be borrowing against the equity. The total loan amount that you receive is the difference between your home’s market value and the balance that you still owe on your mortgage. Keep in mind that you can use the money you obtain from a home equity loan to cover a wide range of different expenses, which include everything from paying off any remaining debt you have to funding an investment.

Home equity loans are very similar to home equity lines of credit. The primary difference between these two types of equity loans is that HELOC loans tend to have variable interest rates. In comparison, standard home equity loans have fixed interest rates, which many borrowers prefer because of the stable and consistent payments. Before you apply for a home equity loan, you should know more about the many advantages that you’ll gain access to with this loan, all of which are detailed in the following.

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Fixed Interest Rates

If you’re thinking about applying for a home equity loan, among the most notable advantages of these loans is that they come with fixed interest rates. Regardless of the type of loan you seek, it will either be paired with a fixed interest rate or an adjustable interest rate. Fixed interest rates remain the same over the course of the loan, which means that your monthly payments are predictable and consistent. When you’re trying to create a monthly budget, having a loan with fixed interest rates means that making your monthly budget should be considerably easier.

Adjustable-rate loans are unique because the interest rates can be changed on a regular basis in accordance with broader market alterations. Applying for an adjustable-rate loan may seem advantageous since these loans typically come with lower interest rates than fixed-rate loans. The initial interest rate you obtain with the loan will remain fixed for anywhere from 1-10 years, after which it will begin to adjust and can increase substantially in a short period of time.

While there’s always a possibility for interest rates to drop once the adjustable-rate period begins, it’s much more common for interest rates to increase, which means that your monthly payments become larger and larger. By obtaining a home equity loan with a fixed interest rate, your interest rate will remain the same even if national interest rates increase in the years to come.

financial paperwork

Lower Borrowing Costs

If you want to obtain the funds necessary to remodel your home or pay down some of your debts, it’s possible to obtain either a personal loan or a home equity loan. While personal loans will give you access to the cash you need to make certain payments, there’s a clear difference between personal loans and home equity loans.

When you borrow money via a personal loan, the loan itself is unsecured, which means that it isn’t backed by collateral. As such, the lender is taking on a considerable amount of risk since it will be difficult for them to obtain the money they’re owed if you happen to default on the loan. In comparison, home equity loans are backed by the home that you own, which the lender can gain access to if you default.

Since the lender can gain back some or all of their money if you default on the loan, they should offer you a reasonable interest rate. In most cases, home equity loans come with lower interest rates than personal loans, which means that your borrowing costs would be lower. Anything that reduces the amount of money you owe on a long-term basis is beneficial to you.

man looking at laptop mortgage

Affordable Monthly Payments

Home equity loans tend to have relatively low and predictable monthly payments, which makes it an ideal loan when you need money to pay for larger expenses. The interest rate you’re able to obtain with your loan will dictate just how affordable your monthly payments will be. Your credit score, the total loan amount, and any debts you have will effectively determine what your interest rate is. Keep in mind that interest rates for home equity loans can range from 3-12%.

Whether you obtain a loan with a 10-year repayment period or a 30-year repayment period, your monthly payments should be affordable. Before you select a term for your loan, you should understand what the different loan terms mean.

Let’s say that you borrow $30,000 with an interest rate of 6%. If the loan term is 10 years, you will be able to pay your loan off quickly but with a monthly payment of $333. The main benefit of this option is that the interest you pay amounts to less than $10,000. As such, you will end up paying the lender around $40,000 over the 10-year period.

In the event that you receive a 30-year home equity loan worth $30,000 at an interest rate of 6%, your monthly payments would be as low $180. While the lower monthly payment is advantageous, the total interest you’ll end up paying over the course of the loan is just under $35,000. This means that you would pay your lender upwards of $65,000 over a 30-year period.

woman holding cash

A Lump Sum to Use At Your Discretion

Another clear advantage of applying for a home equity loan is that you’ll gain access to a lump sum of cash that you can use at your discretion. In fact, the interest that you pay on this loan is tax deductible as long as you use the money to pay for making improvements to your home.

In general, you can use the cash however you want. If you applied for the loan to make renovations to your home, the money can immediately be put towards these improvements. Keep in mind that the right renovations can increase the value of your home by a sizable amount. It’s also common for borrowers to use the money from a home equity loan to pay off some of their high-interest debt.

If you took out a loan a few years ago that came with an interest rate above 15%, you’ll be paying a large amount of interest until that debt is paid off. While a home equity loan is still debt, you would essentially be replacing high-interest debt with low-interest debt, which would allow you to save money in the long run. You can also look into using the cash from a home equity loan to pay for:

  • Emergency expenses
  • Wedding expenses
  • Business expenses
  • Higher education

Potential Tax Benefits

As mentioned previously, another clear benefit of taking out a home equity loan is that you should gain access to some tax benefits. In the event that you use the home equity loan to make improvements and renovations to your home, the interest that you pay on the loan could be tax-deductible as long as the money significantly improves the property. Up to $100,000 in interest can be deducted on your annual taxes.

If you’re not familiar with how these deductions work, let’s say that you pay $5,000 in interest during the year. If your annual income amounted to $100,000, the interest you paid during the year would lower your taxable income to $95,000, which would result in you owing less taxes. Keep in mind that this tax benefit only applies in situations when the money from a home equity loan is used for home renovations.

Considerations

Even though home equity loans come with numerous benefits, there are still a few drawbacks that you should take into account. For instance, it’s possible that you would default on your loan, which would likely result in you losing your home. In order to qualify for a home equity loan, you must have a great credit score as well as equity that amounts to 15-20% of the value of your home. Even when you sell your home, you’ll still be responsible for repaying the loan each month.

A home equity loan can be highly useful if you need money to pay for college or make improvements to your home. These loans tend to come with relatively low interest rates, which are fixed for the life of the loan. Since you receive the payment as a lump sum, you can immediately use the money in any way you see fit. Before you select a home equity loan to apply for, make sure that you shop around to find low interest rates.

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