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What Is a Home Equity Personal Loan?
Securing a loan, like a personal or home equity loan, can be a great way to pay off debt, cover the cost of a financial emergency, pay for home improvements and more. A personal loan is often easier to get, but the best home equity loans come with better rates and terms. A home equity loan is secured by the equity in your home, giving you the loan amount in a lump sum, which you’ll have to pay back over time, generally with a fixed interest rate. Default on your home equity loan, and you risk losing your home to foreclosure.
What is a home equity loan?
The difference between what your home is worth and the current balance on your mortgage is called equity. When you take out a home equity loan, you get all or a portion of that equity in a lump sum. Often referred to as second mortgages, home equity loans are secured, which means you’ll usually get a better interest rate than with an unsecured loan but your home is the collateral.
Most home equity loans have terms ranging from five to 30 years. Although loan amounts vary, most lenders require the combined debt of your original mortgage and your home equity loan to be less than the current market value of your home if you were to sell it today. This is called the loan-to-value ratio (LTV). The lower the LTV, the lower your interest rate. Keep in mind that in addition to your loan payment, some lenders charge fees and closing costs or require a home appraisal just like with a first mortgage loan.
Difference between a home equity loan and HELOC
Home equity loan
A home equity loan is much like a conventional mortgage and is secured by the equity in your home. It comes with separate fees and payments and is often called a second mortgage. You receive your loan in one lump sum at closing, then repay your loan with set rates and terms. Home equity loans are more rigid than HELOC’s but are a great benefit to anyone who needs money from the equity built up in their home for a particular purpose. Home equity loans are also better if you prefer structured repayment terms and monthly payments.
Home equity line of credit
Like a home equity loan, a home equity line of credit (HELOC) is also secured by your house or other property. The difference between the two is that with a HELOC, you draw money from your loan as you need it, much like a credit card. Plus, you only pay interest on the amount you borrow.
Home equity lines of credit also often come with better interest rates and terms than many home equity or personal loans. But unlike home equity loans with set rates and terms, HELOCs have adjustable interest rates, typically the prime rate plus a certain percentage. That means the interest rate you’re paying today may be higher tomorrow.
[Read: How to Find the Best Mortgage Rates ]
Pros and cons of home equity loan
|Pros of a home equity loan||Cons of a home equity loan|
|Rates and terms are fixed Set monthly paymentsSet repayment scheduleRepayment periods up to 30 years||Less flexibility in repayment termsInterest charged on the full loan amountYou’ll likely pay closing costs.Risk losing your home to foreclosureIf you sell your home, the loan is due in full.|
Things to consider before taking a home equity loan
- Under a 2018 tax law, you can only deduct the home equity interest on your taxes if the loan is used for home renovations, and the total amount of home equity debt, which also includes your mortgage, isn’t any more than $750,000.
- If you can’t make your payments on your loan, you risk losing your home to foreclosure. Some lenders have paused foreclosures due to COVID, but your credit will still suffer from late payments.
- In addition to your loan amount, you may be required to pay closing costs on your home equity loan. These costs can be paid upfront at the time of closing, or you can budget them into your total loan amount. Either way, these fees — which can range from 2% to 5% — will add to the overall cost of your loan.
- Unlike a HELOC, where interest is only charged on the amount you borrow, with a home equity loan, you are charged interest on the full amount. Fortunately, in today’s market, interest rates are low.
[ More: How Much House Can I Afford? ]
The 4 best home equity loans
- Best for Cost Transparency: Discover, Member FDIC
- Best for Easy Qualifying: Citi
- Best for High LTV Limits: TD Bank
- Best for High Loan Amounts: U.S. Bank
Home equity loan tax deductions
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