As you pay down the mortgage on your home, the equity you build becomes an asset you can use to secure a loan or a line of credit. You can use the loan or line of credit to make home improvements (including energy efficiency upgrades), consolidate debt, make a large purchase, pay off school loans, cover retirement expenses, or more. Because home equity loans and credit lines are secured by your house, you can get a much lower interest rate than you would if you took out an unsecured loan or used your credit card for the expense.
What is equity?
Equity is, essentially, the portion of your home’s value that you have paid off. So if your home is valued at $165,000 and you’ve paid off $100,000, you have up to $100,000 in equity. Through a home equity loan or line of credit, you can borrow a percentage of the equity you have earned (up to 90%).
Are you eligible for a home equity loan or line of credit?
To determine how much equity is available to you through a home equity loan or home equity line of credit (HELOC), you will need to know the value of your home and the balance on your mortgage.
To determine your home’s value, you can reference a recent appraisal on your home (this may come at a cost to you). You can also check the tax-assessed value of your home—this appears on your property tax bill—but this may not fully reflect the value of your home, depending on how recently the town assessed your home. If your home has not been assessed in a while, you may want to ask a local realtor to draw up a market analysis on your home.
Once you know the value of your home, you can do the math—subtract your mortgage balance from the value to determine the equity you have earned.
If you don’t want to go through the process of determining your available equity, your lender will help. You will need to provide some basic information, including your monthly income and assessed property value. Your lender may opt to conduct a formal appraisal or rely on your tax-assessed value.
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Should I get a home equity loan or a line of credit?
If you’re not sure which product—a loan or a line of credit—is right for you, consider these pros and cons:
Loan pros: Home equity loans are generally fixed rate loans, which means you get the money in one lump sum and will make the same payment each month for the full term of the loan (though the final payment will vary). This is a great option for those who know exactly how much they will need and can put it to use immediately. It is also great for people who are more comfortable with fixed payment amounts.
Note: Not all home equity loans are fixed rate, so confirm that the rate is fixed with your lender.
Loan cons: On the other hand, because a home equity loan is in fact a loan, you get only the amount you ask for. In order to borrow more money, you will need to go through the process of taking out another loan. This can be a problem for those who are not certain how much money they will ultimately need.
Credit line pros: With a HELOC, you are securing revolving credit with the equity in your home. Revolving credit allows you to use the funds if and as you need them. Whatever you don’t use, you don’t pay interest on and you don’t start paying interest on anything until you put the money to use. In this way, a HELOC can save you money if you will be dispensing funds over time, allowing you to put off interest payments until the money is in use.
Credit line cons: The downside to HELOCs is that you pay a variable rate on your debt, which means that your payment can fluctuate from month to month.
Every lender is different, so make sure to ask a lot of questions. Some questions you may want to ask include:
- Does the home equity loan have a fixed rate?
- Is there a penalty for prepayment?
- Is there a charge if I refinance with another lender?
The process and qualifications for taking out a home equity loan or a HELOC are essentially the same. You will need to fill out an application and you may need to speak with a home equity specialist. As with any other loan, you will want to compare the loans and HELOCs of different credit unions and banks to find the best terms and interest rates.
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