What is a home equity loan?
Amazon founder Jeff Bezos might be worth $120 billion, but that doesn’t mean he has $120 billion in the bank. A similar logic applies to your house. It’s worth a certain amount, but that doesn’t mean the walls are lined with that exact amount of cash. The good news, there’s a way to convert a chunk of your home’s value into actual cash and it’s called a home equity loan.
What’s a home equity loan?
Home equity is the value of your home after you’ve subtracted however much you still have left to pay on your mortgage. In most cases, you should build more equity each month as you make your mortgage payments. Your home’s equity can also increase if you make certain renovations or if the property value rises.
Home equity loans allow you to borrow money from a lender using the value of your home. You might hear these loans referred to as a “second mortgage” because that’s a type of debt that uses the equity of your home as collateral. Just like you would with a mortgage, you’re required to make regular payments to cover the amount of your loan, plus interest.
The purpose of a home equity loan is to convert your home’s value into cash. To figure out how much you’ll be able to borrow, there’s some math involved. Lenders will usually let you borrow about 80% to 90% of your home’s value, subtracting what you still owe on your mortgage. For example, let’s say your home is worth $300,000 and your mortgage balance is $100,000. Eighty percent of your home’s value ($300,000) is $240,000 — don’t feel bad, we too had to use a calculator to get that number. Once you have subtracted your mortgage balance ($100,000), you have the maximum amount you can borrow with a home equity loan ($140,000).
Is a home equity loan right for you?
Home equity loans put cash in your hand, and you’re free to use that money however you want. Many people will use a home equity loan to finance their budget for a home remodeling project. But it’s important to remember that there are strings attached to that cash in your hand. Using your house as collateral for a loan means that your home is at risk if you fail to make payments.
It’s also important to consider whether a home equity loan makes financial sense for you. Remember, your regular mortgage payments aren’t going anywhere. Make sure you can afford monthly payments for both your mortgage and your home equity loan.
If you sell your home before you’ve finished paying back your home equity loan, the balance of that loan comes due. There’s also the possibility that your home’s real estate value may decrease, leaving you owing more than your house is worth.
Every loan is a leap. Home equity loans are no different. Thinking through the pros and cons before making a decision is essential. If you’d like to talk through them, please get in touch with us. We’re no strangers to pros and cons lists!