Taking out a home equity loan? These 5 factors matter most, according to experts
High interest rates have forced many potential borrowers to put plans on hold. If you need money right now, you might have to turn to more expensive unsecured options, like personal loans or credit cards. Those options can get costly, as the average personal loan interest rate is almost 12% right now while credit card users are paying an average of more than 21% interest.
However, homeowners have a more affordable borrowing option with home equity loans. Unsecured borrowing options are in double digits, while home equity loans average 8.60% in interest.
"Almost 80% of homeowners have a mortgage interest rate below 5%," says Tom Hutchens, the executive vice president of production at Angel Oak Mortgage Solutions. "By utilizing a home equity loan, a homeowner can tap into this equity while keeping their all-time low first lien interest rate in place."
If you're thinking about taking out a home equity loan, it first helps to know the factors that matter most. We asked some experts for their insight.
Start by seeing what home equity loan interest rate you could qualify for here now.
4 factors to consider when taking out a home equity loan
Ready to proceed with borrowing from your home equity? Here are four factors to account for before doing so, according to the experts we consulted.
Affordability
A home equity loan or home equity line of credit (HELOC) is like a second mortgage. On top of your first mortgage payments, you'll need to make payments on your home equity loan. If not, you could face foreclosure.
"A HELOC is essentially taking out further debt on your home," Hutchens says. "Do you have a clear plan for how you intend to use that money and can you afford to continue to meet your debt payments? At the end of the day, you'll need to pay back this loan while continuing to pay your remaining balance on your first-lien mortgage."
See what your home equity loan payments could look like online today.
Repayment terms
Whether you take out a home equity loan or line of credit, it's important to understand the terms of your agreement. Read the fine print so you aren't caught off guard when it comes time to repay what you borrowed.
"The most important thing is understanding the parameters surrounding the money and repayment," says Adam Neft, a loan officer at GO Mortgage. "Know when the 'full' repayment period begins and how much that payment is. Nobody wants or likes a surprise."
Home equity loans take out a lump-sum amount while HELOCs are a revolving line of credit you can draw from when you need it. Think about the type of home equity borrowing you'll be doing: do you need all your money now or do you want to tap into it as you need it? Then factor repayment into your budget.
Loan usage
Access to your home's equity is one thing, but that doesn't mean you need to spend it.
"Try to fight the urge to use your home equity for direct consumption spending," says Logan Mohtashami, a Lead Analyst at HousingWire. "A lot of homeowners have a ton of equity and feel like they can spend away when, in reality, you're just adding more debt onto your books."
Consider your financial needs and what a home equity loan or line of credit would do. It might be worth it if it would help lower your debt burden or pay off some financial obligations. But if you're using it to pay for a wedding or vacation, try other financing options.
Financial needs
The average homeowner has around $300,000 in home equity right now. But that doesn't mean you should use it all. With large amounts of available home equity, it's easy to get caught up in using it all, even if you don't need it. Instead, only borrow what you need, which could help during the application and approval process.
"Lenders typically offer home equity loans based on the loan-to-value (LTV) ratio, which is the loan amount divided by the appraised value of the home," Hutchens says. "A lower LTV ratio can result in better loan terms."
Do the math on your loan-to-value ratio to see how much equity you have in your home so you know what lenders will expect when you complete an application.
Expectations
A home equity loan or line of credit can be a huge financial lifeline for many homeowners who need to borrow money to cover significant expenses or pay off large financial needs. However, some might use these opportunities for the wrong reasons.
"A home equity line of credit can be used to pay off your high-interest credit card debt," Mohtashami says. "However, this doesn't mean you should feel free to spend money with those credit cards again."
When you use your home equity loan or HELOC, remember that not paying it back could result in losing your home. Making responsible financial choices is important during and after borrowing from your home's equity.
Learn more about your home equity options here.
The bottom line
Not every homeowner's needs will be the same so it's important to talk to a professional before you complete an application.
"No two situations are identical, so it's not a 'one size fits all' proposition," Neft says. "A good loan officer will explain the benefits and (potential) pitfalls of each option."
Hutchens agrees, noting that your previous mortgage loan officer might provide insight into your options based on your situation.
"A mortgage professional can review your situation and give you solutions for your specific needs," he says. "There is a lot of information online but a mortgage professional is your best resource to tailor the right HELOC for your situation."
Mohtashami notes that many lenders aren't handing out home equity loans to unqualified applicants. Make sure you're educated on your options by talking to a pro. "This isn't the wild wild west anymore and lenders don't freely offer home equity lines anymore," he says. "However, having a trusted financial loan officer guide you early on can make the process easier."
