Home Equity Loan – How It Works and Is It Worth It?

How Does a Home Equity Loan Work?

Here’s how a home equity loan works:

1. Loan Approval: First, you must have attained a hefty amount of equity in your home. Lenders typically require a minimum of 20% equity in the property before approving a HEL.
2. Disbursement of Funds: After approval, a homeowner receives a lump sum amount. The amount depends on the equity you have in your home and factors like your credit score and income.
3. Monthly Payments: You will then make regular monthly payments over a fixed term, usually 5 to 15 years.

Pros and Cons of Home Equity Loans

Here are some pros and cons of home equity loans to consider before making a decision:

👍Pros:

• Lower Interest Rates: HEL has lower interest rates than unsecured loans. Here your home is collateral and thus the loan is secured.
• Fixed Payments: Home equity loans provide a predetermined repayment schedule and a fixed interest rate. This means that you know exactly when the loan will be paid off.
• Tax Benefits: The interests on home equity loans are tax-deductible, which can help reduce your overall tax liability.
• Access to Funds: HEL allows you to borrow approximately 80% of your home’s value. This can help you if your financial requirements are high.

👎Cons:

• Foreclosure Risk: Lenders can foreclose your home if you default on the loan since your home is used as collateral.
• Closing Costs: On a home equity loan, closing costs are around 2% to 5% of the loan amount.
• Tapping into Equity: HEL reduces the equity in your home, which may be a disadvantage if you plan to sell soon.

How to Get a Home Equity Loan?

Here are the 5 chronological steps to proceed with a HEL:

1. Check your Credit Score: Start by checking your credit score, a higher credit score will typically result in better loan terms.
2. Determine your Equity: You’ll need a minimum of 20% equity in your home. You can determine it by subtracting the mortgage due from the current market value of your home.
3. Shop Around for Lenders: Research various lenders to compare interest rates, fees, and loan terms.
4. Apply for the Loan: Submit your application, alongside all required documents. The lender will review your application, credit score, and equity to determine if you qualify for a HEL.
5. Close the Loan: If approved for a HEL, the next step is to close the loan. This includes signing loan documents and paying the closing costs.

Home Equity Loans vs. Other Options

If you’re considering a HEL, comparing it with other options is essential. Here are some alternatives to consider:

Loan Type	Features
Personal Loans	1. Personal loans are unsecured loans that can be used for various purposes. 2. They typically have higher interest rates than home equity loans but do not require collateral. 3. It is a good option for those who do not have enough equity in their homes.
HELOC	1. A home equity line of credit is similar to a home equity loan. But instead of receiving a lump sum, you’re given a line of credit. 2. They have variable interest rates and can be a good option if you need to access funds over a longer period.
Cash-out Refinances	1. Here, you refinance your existing mortgage for more than what you currently owe and receive the difference in cash. 2. This option is good if you want a lower interest rate.
Credit Cards	1. This can be a convenient option for smaller expenses. 2. Credit cards typically have high interest rates and can quickly accumulate debt if not paid off each month.

» Cash Out Refinance vs Heloc: Read to know more.

Bottom Line

Home equity loans are a good option to access large funds at lower interest rates. The only risk is that you need to keep your home as collateral.

Valuate your financial situation before taking a final call on HEL. Compare interest rates from different lenders and choose the one, that best suits your situation.

Read Our Blogs on Home Equity Loan

• Home Equity Loan For Buyers: Learn how to use a home equity loan to buy another house.
• HELOC vs Home Equity Loan: Find out the right option for you!
• Home Equity Loan with Bad Credit: Learn how to get approved for a home equity loan with bad credit!

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