By KEMBA Financial Credit Union
For many homeowners, an equity loan is an attractive option for making home improvements, paying for large ticket items (i.e. college, wedding), or consolidating high-interest debt. For other homeowners, an equity loan might not even be an option because they do not have enough equity in their home to qualify.
Before we review the benefits and types of home equity loans, here is a quick review of how home equity is calculated.
Equity is the part of your home that you actually own. If your home is worth $200,000 on the real estate market and the balance of your mortgage is $100,000, the part you own is the other $100,000, or 50 percent equity.
That equity is what a lender uses as collateral against the loan. If there’s no equity in your home, then, obviously, a home equity loan wouldn’t be an option. In fact, you generally need equity of at least 15 to 20 percent of the value of your home to qualify. And, of course, as with any loan there are other considerations such as credit worthiness and income.
Home equity loans are sometimes referred to as a “second mortgage.” But that’s not always an accurate title. Some people own their homes outright, in which case a home equity loan would be their only mortgage.
The advantages of home equity
No matter what you call it, a home equity loan has many advantages over conventional or unsecured loans. One of the biggest attractions is the tax benefit. Interest on a home equity loan is tax deductible—so long as you use the loan to make improvements to that same home—which is a change to the tax law beginning in 2018; before that, all home equity loan interest was tax deductible. (Consult your tax advisor.)
Increasing your home’s value
Home equity loans, when invested in home improvements that add floor space, can increase the value and aesthetic of your home. According to annual listing data provided by Columbus Realtors, the average price-per-square-foot grew by more than 30% from 2014 to 2018. By using a home equity loan to make improvements or increase the square footage of your home, you are increasing the resale value of your most important asset.
Tax considerations aside, you can use a home equity loan on whatever you want, though not all uses may be in your best financial interest. It’s important to weigh the pros and cons.
Consolidating high interest loans
Historically speaking, interest rates on home loans tend to be lower (sometimes much lower) than other types of loans such as a credit card or a car loan. So if your motivation is to stop paying the high interest rate of a car payment, for example, you may save money with a home equity loan by securing a lower interest rate, and perhaps paying the car off sooner. The same scenario is true with credit card debt.
You can use the equity in your home to pay for large ticket items as well. If you have a student going to college or an upcoming wedding to plan, you can use the equity in your home to fund them. While the interest is not deductible, the lower rates you can get from a home equity loan can give you fast access to the funds you need at a lower rate than a high-interest credit card. However, as with every financial decision, it’s important to research the best option for your unique circumstance.
Two types of home equity loans: Standard and HELOC
A standard home equity loan is common when the borrower knows exactly how much money is needed. The loan is advanced as a one-time lump sum of cash. Monthly repayment terms, including a fixed interest rate, are also understood right up front.
With a home equity line of credit (HELOC), borrowers may not know exactly how much money will be required. So instead of a one-time lump sum payment, funds are drawn on as needed up to a maximum limit. Monthly repayments can vary, therefore, depending on how much is borrowed. A HELOC may also feature an adjustable interest rate which is based on the Prime rate set by the Federal Reserve.
Is a home equity loan right for you? Which kind is best? The home equity loan team at KEMBA Financial Credit Union can help answer your questions and secure a loan that makes the most sense for you financially. Contact a KEMBA Member Service Representative at 800.282.6420, option 2.