A home equity loan can be a great way to pay for home repairs or other expenses utilizing the value that your home already has. However, it can do more harm than good if not used properly.
Here’s what you need to know before you sign on the dotted line:
What is a home equity loan?
A home equity loan, sometimes referred to as a second mortgage, is a loan that allows homeowners to borrow against the equity in their home. Like any other loan, the money is received in a lump sum and paid back over time with interest.
These loans are commonly used for home renovations but can be used for anything from debt consolidation to paying for college. Your bank will determine how much you can borrow and what the term of the loan will be.
Home equity loans typically take between 5 and 15 years for repayment, depending on how much you borrow and what you can afford to pay each month.
Home equity loan vs. HELOC
A home equity line of credit, also known as a HELOC, is another type of loan that utilizes your home’s existing value. Unlike a home equity loan that’s disbursed in one lump sum, a HELOC is available for withdrawal on an ongoing basis.
Another way these loans differ is in the interest rates. A home equity loan has a fixed interest rate for the duration of the loan, while a HELOC has a variable interest rate.
Given this information, which loan should you choose? Home equity loans are most commonly used for larger, one-time expenses, while HELOCs are used for smaller, ongoing expenses.
Red flags to avoid
As with taking on any type of debt, you want to make sure that you have a good reason for taking out a home equity loan or HELOC before making a final decision. It might be tempting to use the money to buy something new or go on a dream vacation, but don’t borrow more than you can realistically afford to pay back.
You’ll also want to carefully evaluate your home’s value and its projections over the life of your loan. If you plan to sell your home while the loan is active, you’ll need to make enough money to cover your original mortgage plus the home equity loan or HELOC.