Are home equity loans affordable?

There are a few ways to reach your goal when it comes to paying for big things like home repairs, education, or investment or vacation property. If you are a homeowner, the equity in your home can be the golden ticket to achieving your goals. With a home equity loan, however, there are costs in the form of processing fees, appraisals, and interest. Are home equity loans affordable?

The central theses

  • Home equity loans use your primary residence as collateral for a lump sum loan that is repaid on a fixed payment schedule.
  • Home equity interest rates are tied to mortgage interest rates.
  • Home equity interest rates are significantly lower than credit card interest rates, giving borrowers flexibility.

What is a Home Equity Loan?

Simply put, a home equity loan is a lump sum loan where your primary residence serves as collateral. When you make mortgage payments on your home, you build equity. If the value of your home increases due to market developments, your equity will also increase.

A home equity loan is a very flexible instrument – ​​terms range from 5 to 30 years with fixed interest rates and payments. And because the loan is paid out in one lump sum, you can use it for anything you want, including renovating your home, paying off higher-interest debt, or financing an education.

But a home equity loan doesn’t come without a cost. Because a home equity loan is a second mortgage, the fees and application process are very similar. Fees vary by lender, but typically include appraisal fees to quantify the amount of your equity, as well as creation fees, which can consist of record fees, document fees, etc.

Home equity loans also earn interest. Interest rates on home equity loans are typically slightly higher than interest rates on traditional mortgages. This is to protect the lender in the event of a default. If you fail to make payments on your home loan or home mortgage, your home could be taken over by the lender and sold to recoup their costs. In this situation, the main mortgage is paid off first, with the excess proceeds going to the home equity loan.

Tip

While home equity loans and home equity lines of credit both increase the value of your home, home equity loans have fixed interest rates. When interest rates are volatile, a fixed rate can save you money.

Are home equity loans affordable?

Affordability is a highly subjective concept. Compared to other forms of financing, home equity loans are for large amounts, such as B. Cash advances from a credit card or payday loans, clearly affordable. Because their interest rates are fixed for the life of the loan, it should be easy to assess whether your payments are manageable with your current budget.

When it comes to similar products, a home equity line of credit (HELOC) is the next option. Compared to a HELOC, which also uses your home’s equity as collateral, a home equity loan can be less expensive. Typically, HELOCs have adjustable interest rates. While this can be an advantage when interest rates are falling, when interest rates are rising, borrowers may find that the revolving line of credit is more expensive than a home equity loan.

What can I use a home equity loan for?

You can use a home equity loan for anything. Since it is a lump sum, your lender has no control over how the funds are used. But while you can use the money for anything, it would be wise to use it for something with a small return. Using funds for improvements that increase the value of your home would be more prudent than using them for a vacation.

Are home interest rates rising?

2022 has proven to be a volatile year for mortgage rates, and they have almost doubled since last year. But even though interest rates have risen, they still don’t match the rates charged on most consumer credit cards. A home equity loan is still a cheaper way to fund projects for amounts that can’t be repaid quickly.

How much does it cost to apply for a home equity loan?

Closing costs vary from lender to lender. Some lenders may waive some fees as a perk, but generally you pay for an appraisal, a preparation fee, a document preparation fee, a credit report fee, and a title search. Typically, closing costs range from 2% to 5% of your home loan amount. Many lenders will include these costs in your loan payment to avoid upfront fees.

How Much Can I Borrow With a Home Equity Loan?

Your total loan amount depends on how much equity you have in your home. Most lenders will only let you borrow up to 80% of your total equity.

The final result

Home equity loans are flexible tools for homeowners to borrow significant amounts of money. With interest rates that are typically slightly higher than mortgage rates but significantly lower than credit cards, they offer affordable access to cash. While mortgage rates are rising, they are still low enough to make a home loan attractive to the average homeowner.

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