You may have heard the term “home equity loan” thrown around as a way to finance a remodel or an answer to financial troubles. But there are some things you need to know before taking out that loan — like what a home equity loan is, what it can be used for, and how to use this kind of loan.
What is a Home Equity Loan?
Home equity loans are also known as second mortgages because they are tied directly to your home. These loans allow you to borrow money against the value of your home.
There are two types of home equity loans:
- Fixed-rate loans: These allow borrowers to borrow a lump sum of money which they have to repay at a fixed amount and interest rate.
- Home equity lines of credit: With this type of home equity loan, the borrower can use the money gradually. The money owed each month varies based on how much was borrowed.
Many people use home equity loans to pay for major life events because these loans can provide quick money at a reasonable interest rate — and the interest is tax-deductible up to a certain amount.
Reasons to Take Out a Home Equity Loan
There are many reasons why you might want to take out a second mortgage, some dealing with the home itself and others dealing with major life events.
- Home improvements: Whether you’re fixing a hole in your roof, making renovations in order to sell your home, or working on a “fixer-upper,” a home equity loan can help you pay for it. All of these can add value to your home, making it worth more money if and when you do sell it.
- Expected life events: College tuition for your teenager and bringing a new baby into the world can both lead to heavy financial burdens that home equity loans can help lessen.
- Unexpected life events: Medical bills and other expenses often arise without enough warning to get your finances in order. Home equity loans can help here, too.
Home Equity Loan Tips
Know Which Kind of Home Equity Loan is Best for You
For emergency medical bills or home improvements, a fixed-rate loan will probably be your best bet because you usually need to pay for these things all at once.
Paying for college or for a new baby requires a different kind of spending. Since you don’t pay for all four years of college at once, and you certainly don’t pay for all 18 years of a child’s life at once, a home equity line of credit might be more beneficial.
Make Sure You’ll Be Able to Pay It Back
If you’re already drowning in debt, avoid a home equity loan. Taking out a loan to pay your other debts, or reloading, can end up leading you further and further into debt. Having a set plan to pay off your second mortgage is crucial to avoid getting in over your head.
Home equity loans are useful to many, but they are not always necessarily your best options. When making your decision, consider all of your choices. Would refinancing your home or taking out a different kind of loan benefit you more?
The answer depends on your specific case, so talk to a home equity loan advisor to help you determine the best solution for your needs.