If you’re a homeowner, chances are you’ve been offered a home equity loan once or twice before. And we get it, those little flyers that come in the mail offering you a ton of cash on the spot can be pretty appealing. But just remember, there’s a lot of hidden information in that fine print.
A home equity loan can certainly be a good option, especially for those looking to make major improvements to their current home. But before you dive deep into a loan that puts your house on the line, you need to have all the facts. Here are seven key points to help you understand the wild world of home equity loans, and to help you consider if using your home as collateral is really worth it.
Home Equity Loan Definition
If you’re looking for a home equity loan explainer, you’ll find that the term is actually a catch-all for several different types of loans including fixed-rate home equity loans, home equity lines of credit (HELOCs), and cash-out refinancing.
Each of these loans come with their own unique perks and downsides, but essentially, a home equity loan allows a homeowner to use their house as collateral for cash. That cash typically comes as a lump sum, fixed-rate loan paid to the consumer all at once. Then, that consumer pays back the loan plus interest over time. Or in the case of a home equity line of credit, the loan functions as revolving debt.
Who is a home equity loan good for?
A home equity loan is typically good for those who want to take out a large sum of money for home renovation projects, especially if the renovations could potentially increase the value of the house. Others use these home equity loans to pay off other large debts, such as student loans. To get an estimation of the resale value of your next home improvement project, use SoFi’s Home Project Value Estimator.
“Most families with student loan debt would do better using home equity to eliminate that debt, instead of resorting to using credit cards as a short-term solution,” Helen Huang, Senior Director of Product Marketing for SoFi’s Home Loan products, said in a previous statement. “Mortgage interest rates are often lower than student loan interest rates. So homeowners can use that to their advantage. Paying off student loans with equity means making only one payment per month, which not only simplifies life, but can also save borrowers money.”
Really, this course of action is popular for those looking to borrow $25,000 or more, and those who are sure they can pay back the loan within a reasonable amount of time.
How to Calculate Home Equity
How much home equity can you tap into? It boils down to this: If your home is valued at more than what you currently owe on your mortgage loan, you have equity.
For example, if you withdrew a $300,000 mortgage several years ago, and have since paid back $100,000 of what you owe, you then have $100,000 in available equity from your home. That means you can borrow against that $100,000 for home improvements, student loans, or other bills using a home equity loan. Even if you haven’t paid off a lot of your home, you may want to check if it has appreciated, because if your home has gone up in value, your equity has increased.
To get this loan, you can contact a mortgage lender, who will order an appraisal of your home to find out its current worth. Then, next steps would be to gather your tax information, pay stubs, and bank statements for the home equity application process.
What’s the Difference Between a Home Equity Loan and a HELOC?
There is another option in the home equity loan game known as a HELOC, or a Home Equity Line of Credit. A HELOC also uses your home’s value as collateral. However, instead of receiving a lump sum payout like you would with a traditional home equity loan, a HELOC works more like a credit card. This means people can instead borrow money on a rolling basis up to the credit limit —which is the equity on their home — and pay back the balance all at once or over time.
Interest rates on HELOCs are usually variable, meaning the rate can fluctuate with the market. So, unlike the fixed-rate home equity loans, you could end up paying more over time. HELOCs, like home equity loans, are also most often reserved for those looking to cover the cost of a major renovation.
How is a HELOC Calculated?
When taking out a HELOC, people can typically access to up to 85% of the value of their home, minus the amount they still owe on their mortgage. So, using the same example above, if you took out a $300,000 mortgage several years ago, and have since paid back $100,000 of what you owe, you then have $100,000 in available equity from your home. But, with a HELOC you’d only be able to take 85%, or 85,000 of that equity as a line of credit.
And you can draw from it for five to 10 years, depending on your lender and your “draw period.” During that time, you typically make interest-only payments. Once the draw period is complete, you can start repaying the loan in full, with a repayment term of up to 20 years.
Borrowing Money without Borrowing against Your Home
Remember, there’s no such thing as a free lunch. With a home equity loan or a HELOC you are literally putting your house on the line. So, if you aren’t positive you can pay back the line of credit or the loan, you may want to think about other options.
If you’re only in the market for a one-time, small cash infusion, consider taking out a SoFi personal loan instead. With a personal loan, people can borrow money for any kind of personal use, including home improvement projects, paying off credit card debt, or paying for a vacation.
Related: Find out how much it would cost to renovate your home with SoFi’s Home Improvement Cost Calculator.
And with a personal loan, you don’t have to put up any collateral, meaning you do not have to put your home on the line to take out anywhere from $5,000 to $100,000.
To repay the loan, consumers make monthly payments of principal plus interest over a given amount of time. The best part of these loans may be the fact that if you find yourself out of work, SoFi will temporarily pause your payments and even help you find a new job so you can get back on your feet. So, rather than risking the roof over your head, check to see if a personal loan meets your needs first.
SoFi doesn’t provide tax or legal advice. Individual circumstances are unique. Consult with a qualified tax advisor or attorney.