If you are looking for a source of cash, it is possible to tap into the equity of your home. As long as you have built up enough ownership in your home (known as “home equity”) you may be able to borrow against it. This type of arrangement is known as a home equity loan (HEL) and it can provide you with money that you might not otherwise have access to.
Home equity loans are also sometimes called “second mortgages.” In most cases, the funds from a home equity loan are distributed in one lump sum. It is possible to receive your funds in installments, but most people prefer a lump sum so they can use the cash for whatever purpose they decide.
Advantages of Home Equity Loans
There are various benefits to home equity loans. When you take out a loan based on the equity in your house, it is considered “secured debt” because it uses your home as collateral. You can often get a lower interest rate on a home equity loan than you would get for an unsecured loan ― and this can result in thousands of dollars in savings.
Another advantage is that many home equity loans have interest that is tax-deductible (similar to the interest on a regular mortgage loan). Deducting loan interest on your tax return helps reduce your taxable income, saving you more money.
The funds you get from your home equity loan can be used for a variety of reasons. The most popular motives are debt consolidation, home improvements, and money for vacation.
Disadvantages of Home Equity Loans
One of the main problems with a home equity loan is that you are securing the loan with your home. If something happens and you cannot afford to make the loan payments, you could lose your home.
If you are making home improvements, this type of equity financing can cause huge setbacks (since you’ll have to apply for an entirely new loan if you need more money to complete your renovations).
Applying for a Home Equity Loan
When you apply for a home equity loan, your credit will be checked and the lender will need to know exactly how much equity is in your home. If you are approved, your credit score will determine the interest rate you get. If you do not have at least 20% equity (meaning you have paid down 20% of your principal mortgage balance), you may not be approved for a home equity loan. Note that some lenders require even more than 20% equity.
You do not need to get a home equity loan at the same bank where you have your primary mortgage loan. It’s recommended that you shop around before deciding on a lender for your home equity loan. Look for the best deal ― one that will meet your cash needs and help you reach your financial goals.
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