Getting the right home equity loan is all about finding the best rates. Interest rates on home equity loans are typically higher than your first mortgage, but much lower than credit cards or personal loans. So if you happen to own your house and need cash, a home equity loan or home equity line of credit can be an attractive option.
What Can I Use a Home Equity Loan For?
First you must identify the reason for the loan. Borrowers use home equity loans for a variety of purposes. The most popular, and sensible option is home improvement.
Using the cash payout of a home equity loan to fix up the very home whose equity you are tapping is a no-brainer. Updated, state of the art kitchens and bathrooms, remodeled garages and basements, clean and creative landscaping, and improved flooring can all increase your home’s value and make it more attractive for resale. The latest appliances, and especially green energy systems can also contribute considerably to your home’s market price.
Another popular use for home equity loans is to consolidate debt. Since the interest on home equity loans is tax deductible, paying off credit cards and other higher rate loans with the home equity proceeds is an option worth considering. In this scenario borrowers get one payment, a lower rate, and benefits at tax time.
How Much Can I Get?
You must also have some kind of idea of how much you are going to qualify for. These days, most home equity loan and HELOC lenders will use the following method to calculate the amount they will give you. They’ll take 75% of your home’s appraised value and subtract the balance of your first mortgage.
So let’s say your home is currently worth $350,000 and you have a $200,000 balance on your first mortgage.
|75% of $350,000 = $262,500|
|$262,500 - $200,000|
|Home equity loan/HELOC amount = $62,500|
Some lenders are not this conservative and will offer you anywhere from 80% to 125% of your appraised value. We recommend against this as if your home does not appreciate in value much, or at all, you might still be on the hook for the loan even after you’ve sold the house.
Home Equity Loan vs HELOC
Next you must choose which type of home equity loan fits your needs. Lenders offer two types: the straight home equity loan, and the home equity line of credit (HELOC).
A traditional home equity loan is a straight, lump sum payout that has a fixed interest rate and a fixed term. It is essentially a second mortgage, but instead of using the funds to pay for a house, you can use them for anything you want.
Straight home equity loans are ideal for big, one time purchases or major expenses. If you are looking to put in a backyard pool, or install wood floors, this is the option for you. There will be closing costs, but they will be less than a first mortgage.
With a home equity line of credit you will get approved for the same amount, but will not receive it all at the same time. The money exists as a credit line with a set amount and you can withdraw funds as needed. You will only have to pay interest on what you have taken out and don’t have to begin repayment of the actual loan until the “draw period” is over, usually ten years.
A HELOC is ideal for those who will need to have access to varying amounts of money over a long period of time. Maybe you are doing a series of home improvement projects, or are unable to work for a time due to a disability. Keep in mind, though, that HELOCs have variable rates, so the interest you will owe will fluctuate with the market. Also, once the draw period has expired you will be unable to take more money and must start active repayment of what you have borrowed.
Once you decide on the type of home equity loan, you are going to need to decide on the term. Although mortgage-length terms are available, most home equity loans and HELOCs have terms of 5-15 years. If you are taking out a straight home equity loan with a lump sum payment, the term will basically be dictated by what you can afford each month. But remember, as with all loans, longer terms mean higher interest rates.
The HELOC term will be dictated by how long you need access to the credit line. The longer the term, the higher the rate, and the longer interest has to accumulate which you must pay on whatever you withdraw.
Since home equity loans and HELOCs use your home as collateral, your approval and interest rate are not as much influenced by your credit score as other loans. Also, the approval process is easier and fees less than a first mortgage.
What Is the Average Interest Rate on a Home Equity Loan?
The three-month national trend in interest rates for home equity loans has held at 5.21%-5.22%. Rates for 30-year HELOCs have had more movement at 5.1%-5.37%, that’s an average of 5.235%. These rates can be lower or higher depending on your area. An online marketplace like LendingTree can find you the best rates from multiple partners.
At Consumer’s Advocate, our top three home equity loan and HELOC affiliates are: