Home Equity Loans 101: Borrowing Against Your Nest Egg Wisely

written by

Jim Mucci

posted on

November 22, 2024

Your home is like a piggy bank. When you own a home and pay your mortgage, you build up money inside it. This is called equity. You can borrow some of this money while still living in your home.

To find out how much you can borrow, take what your home is worth now. Then subtract what you still owe on it. Banks will let you borrow up to 85% of that amount.

You need two things to get this kind of loan. First, you must have good credit scores. Second, you must show you make enough money to pay it back.

You can get two types of loans. One has the same payment each month. The other lets you borrow money when you need it, like a credit card.

Many people use these loans to fix up their homes or pay off other bills. But be careful. If you can't pay the loan back, you could lose your home. Think hard about this choice before you borrow the money.

What Is Home Equity

Think of home equity as your share of your home's worth. It's what your home is worth today minus what you still need to pay on it.

Let's say your home is worth $300,000. If you still need to pay $200,000 to the bank, then you own $100,000 of your home. That's your home equity!

You can grow your share of the home in two ways. First, your home might become worth more over time, just like how old toys can become more valuable.

Second, each time you pay your monthly bill to the bank, you own a bit more of your home. It's like filling up a piggy bank – the more you put in, the more you own.

As time goes on, you'll own more and more of your home, which can help you later if you need to borrow money.

Calculating Your Available Equity

Let's figure out how much money you can get from your home. Most banks will let you borrow up to 85% of what your home is worth. But first, you need to subtract what you still owe on your home loan.

Your Home's Worth	What You Still Owe	Money You Can Borrow
$300,000	$200,000	$55,000
$500,000	$300,000	$125,000
$750,000	$400,000	$237,500

To find out how much you can borrow:

Take what your home is worth
Times it by 0.85
Subtract what you still owe

For example: Your home is worth $300,000 and you still owe $200,000.

$300,000 × 0.85 = $255,000

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$255,000 – $200,000 = $55,000

Banks will look at your credit score and how much money you make before they say yes to your loan.

Fixed vs. Variable Rates

You have a big choice to make about your home loan rates.

Let's break it down in a simple way.

Fixed rates are like a promise. Your payment stays the same each month. You know what to pay, and it never goes up or down.

Variable rates start lower, which can save you money at first. But they can go up or down like a seesaw. When they go up, you pay more. When they go down, you pay less.

Think about what works best for you.

Do you like knowing exactly what you'll pay? Pick fixed rates.

Are you okay with payments that might change if you can save money? Then variable rates might be right for you.

Rate Types Compared

Picking a home loan rate is a big choice. You can get a rate that stays the same or one that changes.

A fixed rate never changes. Your monthly bill will be the same each time. This makes it easy to plan your money. You won't have to worry about paying more later.

A rate that changes often starts lower. This means you pay less at first. But watch out! The rate can go up or down with time. If it goes up, you'll need to pay more each month. If it goes down, you'll pay less.

Think about what makes you feel safe with money.

Also think about how long you want to keep the loan. This will help you pick the best rate for you.

Market Impact on Rates

When you borrow money for your home, rates can go up or down. This depends on how well the economy is doing. The Federal Reserve is like a big bank that helps set these rates.

If rates are going up, it's smart to get a fixed rate. This means your rate stays the same. If rates are going down, you might want a rate that can change. This way, you pay less when rates drop.

Your local area matters too. If homes are selling well near you, you might get better rates.

Keep an eye on jobs, prices, and how much money people are making. This helps you pick the best time to borrow.

Payment Stability Differences

Getting a home loan with fixed rates means you'll pay the same amount each month.

Think of it like having the same lunch money every day – you know exactly what to expect. This makes it easier to plan your money and keeps you safe when bank rates go up or down.

A different type of loan, called a HELOC, can change how much you pay each month.

It's like having lunch money that changes based on what's happening at the bank. You might start by paying less than a fixed loan, but your payments could go up if bank rates rise.

When picking a loan, think about what makes you feel safe with your money.

Fixed rates help you sleep better at night. But if bank rates stay low, you might save more money with a HELOC.

Common Uses for Equity Loans

When you want to borrow money using your home, you can do two main things.

First, you can fix up your home. This means making your home nicer and better. When you make your home better, it can be worth more money later.

The other way is to pay off your other bills. When you have many bills with high costs, you can use your home loan to pay them all at once. This makes your monthly bills smaller and helps you save money over time.

Home Renovations and Repairs

Making your home better is one of the main reasons people get home loans. You can use the money from your house to fix things up. Big jobs like new kitchens, fresh bathrooms, or fixing the roof can make your home worth more.

When you plan to fix up your home, this money can help with both the work you want to do and any surprise fixes you need. Making your home better helps you enjoy it more. It can also make it worth more money when you sell it.

Try to fix things that make your house strong and safe. Fix old parts that waste energy. Pick the jobs that will keep your home worth a lot or make it worth even more.

Debt Consolidation Benefits

Getting out of debt is easier when you use your home's value to help. Think of it like trading many small debts for one big one that costs less. You can take all your credit card bills and mix them into one loan that uses your house to get a better deal.

This can help you in simple ways:

You only need to pay one bill each month instead of many.
You pay less money in fees and interest.
You can feel good about fixing your money problems, just like many other smart homeowners.

When you use your house to get a better loan, you can save lots of money each month. But always be careful – if you can't pay the loan, you could lose your home.

Make smart choices about how much you borrow. The lower cost of this type of loan helps you save money over time. Many people find they can breathe easier when they only have one payment to think about each month.

Qualifying Requirements and Credit Scores

Getting a home equity loan is like asking to borrow money using your house as backup. You need good credit – think of it as your money report card. Most banks want to see a score of at least 620, but if you get above 700, you'll get better deals.

The bank needs to know you can pay back the loan. They look at how much money you make and how much you spend each month. They also check if you have paid your bills on time. You'll need to show them your pay stubs and tax papers.

Your house needs to be worth enough money too. The bank will send someone to look at your house and tell them what it's worth. You need to own at least 15-20% of your house's value before you can get the loan. This is like having saved up some of your house payment already.

They also want to see that you've had a steady job for at least two years. This shows them you can keep making money to pay back what you borrow.

Home Equity vs. HELOC

Let's think about picking between two ways to borrow money using your home.

A home equity loan gives you all the money at once, like a big payment. The rate stays the same, just like your monthly bill. This is good when you need money for one big thing.

A HELOC works more like a credit card. You can take money when you need it. The rate can go up or down. At first, you only pay back the interest part. This works well if you need money over time or aren't sure how much you'll need.

Think of it like this: A home equity loan is like buying a meal – you pay one set price. A HELOC is like having a tab at a restaurant – you can keep getting food when you want it.

Fixed vs. Variable Rates

When you get a loan using your home, you need to think about interest rates. You'll pay this money on top of what you borrow.

A home equity loan has a rate that stays the same. This means you pay the same amount each month. It's like having the same lunch money every day.

A HELOC works more like a credit card. The rate can go up or down. Your payments might change from month to month.

To pick the right one, ask yourself:

Do you want to know exactly what you'll pay each month?
Are you OK with payments that might change?
How fast do you plan to pay back the money?

If you like to know what's coming, pick the rate that stays the same. If you can handle change and want to start with lower payments, the changing rate might work for you.

Borrowing Structure Differences

Getting money from your home can work in two ways.

Think of a home equity loan like getting all your birthday money at once. You know exactly how much you'll need to pay back each month.

A HELOC is more like having a piggy bank you can use over and over. You only pay for what you take out. It's like having a special bank card that lets you borrow money when you need it.

But be careful – your monthly payments can change based on how much you use and what the bank charges.

With a home equity loan, you get one big sum and make the same payment each month. This works well if you want to fix up your house or pay off other bills.

A HELOC lets you take money out many times, but you need to watch your spending closely since your payments can go up or down.

Repayment Terms Compared

When you get a home equity loan, you make the same payment each month. This never changes. The payment covers both the loan amount and interest. Most people take 5 to 30 years to pay it back.

A HELOC works differently. At first, you only pay interest on what you use. Later, you start paying back the money you spent.

Things to know:

Home equity loans have steady payments you can count on
HELOCs let you pay less at first, then more later
You can pay off both types of loans early if you want to

The clear payments of a home equity loan make it easy to plan your bills.

With a HELOC, you get more choices about how much to pay each month at first. Both loans put you in control of your money.

Understanding Interest Rate Terms

When you get a home loan, you need to know about interest rates. Think of them like the cost of borrowing money from a friend.

Some loans have fixed rates. This means your payment stays the same each month, just like paying the same rent.

Other loans have rates that can go up or down, like the changing price of gas. Your rate depends on things like how good you're with money and how much your house is worth. Banks look at these things before they tell you what rate you can get.

If you pick a loan with changing rates, the bank will tell you when the rate can change. Some change every month. Others change once or twice a year.

Always ask the bank to tell you how and when your rate might change.

Monthly Payment Considerations

Let's talk about your monthly home payments. You have two choices for interest rates. You can pick a rate that stays the same each month. Or you can pick one that goes up and down based on what's happening in the market.

Your choice will affect how much you pay each month. If you pick the rate that stays the same, you'll know exactly what to pay each time. If you pick the rate that changes, your payments might be different from month to month.

You also need to think about other costs. These include paying back the money you borrowed, loan insurance, and extra fees.

All of these things add up to what you'll pay each month.

Fixed Vs Variable Rates

Money for your home can come with two types of rates. You can pick one that stays the same or one that changes.

A rate that stays the same means you pay the same amount each month. This helps you know what to expect. Many people like this because it's easy to plan ahead.

A rate that changes can go up or down. It often starts lower, which means smaller payments at first. But be careful – your payments could go up later if rates rise.

Think about what works best for you:

A same-rate loan keeps things simple
A changing-rate loan starts cheaper
Pick what feels right for your wallet

The choice is about how much risk you want to take. If you like to play it safe, go with the same rate. If you're okay with change and want lower payments now, try the changing rate.

Remember: The changing rate starts lower but might cost more later. Make sure you can handle bigger payments if they come.

Calculating Total Monthly Costs

Getting your total monthly costs for a home loan is simple! Let's break it down.

Your main payment has two parts – paying back what you borrowed plus interest. But there's more to think about.

You need to add:

A piece of your yearly property tax each month
Money for house insurance
Extra insurance if you borrowed more than 80% of your home's worth

Other costs you might have:

Fees to start the loan
Papers to check house value
Insurance to protect your house title

Start by finding your base payment. Then add these other costs to get your true monthly bill.

Keep in mind that taxes and insurance can go up or down over time, which can change what you pay each month.

Tax Implications and Deductions

Getting tax breaks on home loans is different now than it was before 2018. The new tax law changed the rules. Now, you can only get a tax break if you use the money to work on your home. This means buying a home, building one, or fixing one up. You can't get the tax break if you use the money to pay off other bills.

To get the tax break:

You must list all your tax breaks one by one
Your home loans must be less than $750,000
You must show proof that you spent the money on your home

The words are simpler now. More people take the basic tax break instead of listing things one by one.

If you want this tax break, keep good records of how you spend the money on your home.

Risks of Defaulting

Missing payments on your home loan can hurt you and your family. Think of your home like a promise you made to the bank. If you break that promise by not paying, the bank can take your house away.

Your credit score will drop a lot. This means it will be hard to get new loans or credit cards when you need them.

You will also have to pay more money in fees when you miss payments. The bank might even take money from your paycheck to get what you owe them.

If you can't pay your loan, talk to your bank right away. Many banks want to help you keep your home. They might change your payment plan to make it easier for you to pay each month.

Remember: Your home matters. Get help early if you're having trouble with payments.

Application Process Steps

We want to help you get a home equity loan! Here's what you need to do:

First, get your papers ready. You'll need:

Tax papers
Pay stubs
Bank records

Next, let the bank look at your money story. They want to make sure you can pay back the loan. They'll check your credit score.

Then, a home expert will visit your house. They'll tell you what your house is worth today. This helps the bank know how much money they can loan you.

Last, you'll meet with the bank. They'll show you the loan papers. Read them well. When you sign them, you can get your loan money.

Simple steps:

Get your money papers ready
Let the bank check your credit
Have an expert look at your house
Sign the loan papers

Many people just like you take out these loans. The bank will help you through each step.

Costs and Closing Fees

When you get a home loan using your house, you need to pay some fees. Think of these fees like tickets you need to buy before entering a show.

You pay a small fee to ask for the loan – about $25 to $50. Someone will look at your house to see what it's worth – this costs $300 to $500. The bank needs to check if your house papers are good – that's $100 to $250. They also look at your bill-paying history for $30 to $50.

The bank takes a fee of 1 to 5 cents for every dollar you want to borrow. You also pay people to fill out papers, sign them, and save them at the town office. You need house insurance too, to keep the bank safe.

You can pay extra money called points to get a lower monthly payment. Each point costs one penny for each dollar you borrow.

All these fees add up to about 2 to 5 cents for every dollar you want to borrow. Make sure you count these costs when you plan your loan.

Repayment Options and Strategies

Getting your home equity loan paid back is all about picking the way that works best for you. You can pay the same amount each month, or choose a plan that fits when you have money coming in.

Banks let you pick between two main ways to pay:

Fixed payments:

You know exactly what to pay each month
The amount stays the same
This makes it easy to plan your money

Flexible payments:

You can pay less at first
This helps when money is tight
You can pay more when you have extra cash

A smart tip is to set up your bank to pay the loan on its own each month. This helps you:

Never miss a payment
Keep your credit score strong
Maybe get a lower rate

When you can, try to pay extra on your loan. This cuts down what you owe faster and saves you money over time.

Market Value Impact

Your home's value is like a piggy bank. When you borrow money against your home, it's like taking money out of that piggy bank. The amount your home is worth can go up or down based on what's happening in your area and the economy.

When you get a home loan, you now owe more money on your home. The loan doesn't make your home worth more money right away. But if you use the money to make your home better, like adding a new kitchen or bathroom, your home might be worth more later.

Be careful not to borrow too much. If home prices drop a lot, you might end up owing more than what your home is worth.

This is why it's smart to leave some room between what you borrow and what your home is worth.