Home Equity Loans | How They Work & Best Lenders
If you need money and have built equity in your home, then you might be considering a home equity loan. Over the last few years the home equity loan market has become increasingly popular with increasing home values and a recovering economy. However, changes to the tax code from the end of 2017 may slow down the home equity loan market.
A home equity loan is an installment loan where your house is used as security or collateral on the loan. Of course, you can only take out a home equity loan if you have equity available in your home - either because you don’t have a mortgage, you’ve paid off part of your mortgage, or your home has increased in value since you bought it allowing you to borrow against that increase.
Why would you want to get a home equity loan instead of a personal loan or other type of loan?
There are a number of benefits to getting a home equity loan, including saving money because you’ll likely qualify for lower interest rates because you’re using your home equity as security on the loan.
Read on to learn more about home equity loan borrowing limits, pros and cons, use cases, and the top home equity lenders and companies available today.
Home Equity Loan Uses
The good news is that a home equity loan can be used for anything. Want to pay for vacation? Think it's a good idea to buy another house or investment property? Want to consolidate or pay off credit card debt? Need to renovate your home?
You can use the money you borrow from a home equity loan to do so. No one will check what you used your loan on – it’s your money. People generally use their home equity loans for things that make financial sense, however.
Home Renovations
Some people might get a home equity loan to finance a home renovation like taking out the pink tile and shag carpeting in their bathroom or building a deck on their home. These are great reasons to take out a home equity loan because these improvements could actually increase the appraised value on your home and thus generate more equity for you. While they might not completely earn back your investment, you’ll be able to enjoy the changes while you live in your home and potentially cash out when you sell it.
Managing Debt
Other people use home equity loans in order to refinance and pay off other debt. Have credit card debt? High interest personal loans? Why pay a high rate when you can consolidate them with a home equity loan, get a lower rate, and get the opportunity to deduct the interest on your loans come tax time?
Large Purchases
Still more people might use a home equity loan for big purchases like buying a car, a boat, or to use as the down payment on a second home or investment property. These purchases are less common and could potentially lead to elevated financial risk. Just because you have equity available in your home doesn’t mean you should tap it and treat it like your own personal piggy bank.
Since not paying a home equity loan back could result in you potentially losing your house, you don’t want to take borrowing money against your house lightly and you want to make sure that you have a good emergency fund in order to protect you if something unexpected happens so that you don’t fall behind on your repayments.
Home Equity Borrowing Limits
Thinking about getting a home equity loan and wondering how much you can borrow? That’s fairly simple to figure out. You can only borrow against the amount of equity you have in your home. But there’s a catch! Most banks and lenders won’t let you borrow 100% of the value of your home. Instead, they only let you borrow up to 80% or 90% of the total value.
How do banks calculate how much you can borrow? They look at the amount that your home is currently appraised for and minus what you owe on your mortgage or other home equity products, and whatever percentage of buffer they require.
Here’s one example of a calculation: let’s say you bought your home a few years ago for $200,000. At the time, you put down a $40,000 or a 20% down payment and so you only took out a $160,000 mortgage. You’ve paid down around $30,000 of your mortgage principal since you bought your home and now only owe $130,000 and your home is now worth $240,000. That means that you have $110,000 in equity ($40,000 + $30,000 + $40,000) and the most you could borrow via a home equity loan that will only let you borrow against 80% of your equity is $62,000 since $62,000 and $130,000 add up to $192,000 or 80% of your home’s value.
But not so fast! The bank or lender might have other rules about how much you can borrow. For example, they might only give out loans up to $50,000 or they might have loan minimums of $25,000. Only want to borrow $5,000? You might be out of luck with some banks or lenders. That’s because processing the paperwork on a loan is time consuming and expensive for the lender and they want to make sure they’re able to earn enough back on the loan.
That means that finding the right loan for you is a bit like a matchmaking process. You might find a lender who is a good fit in one area, but they might not let you borrow the amount that you want.
Home Equity Loan Pros
Low Interest Rates
One of the biggest benefits of using a home equity loan is the low rates that are offered on these types of loans. Generally, home equity loans have some of the lowest rates. That’s because the loan is secured by the equity in your home. That equity reduces the risk that you won’t pay the banks back and allows them to potentially seize your home in case you fail to repay in order to sell it and recoup their money. Because the risk is lower for the lender on a home equity loan versus an unsecured personal loan, they generally pass the savings on to the borrower through low rates.
If you also have great credit, these rates tend to be just a few percent higher than the prime rate and often several percent lower than other types of loans that you might qualify for from other lenders. For this reason, a home equity loan is a great type of loan to consolidate other types of debt – especially debt with high interest rates like credit card debt.
Easier Qualification Requirements
If you don’t have great credit, it might also be much easier for you to qualify for a home equity loan rather than another type of unsecured loan. This is because the lender will feel more secure knowing that they have collateral. If you have very bad credit, a home equity loan might be the only type of loan you’ll be able to qualify. Even if you are able to qualify for other loans, they’ll likely charge you a significant amount in interest.
May Qualify for Large Loan Amounts
You’ll also likely be able to qualify for a larger amount of money via a home equity loan than you could if you tried to borrow money via an unsecured personal loan regardless of the state of your credit. Of course, this also depends on how much equity you have in your home.
Interest Tax Deduction for Home Improvements
Another benefit of a home equity loan is that you’ll save money because you can deduct the interest you pay on the loan come tax time. Just like you can deduct the interest that you pay on your mortgage on your taxes via the mortgage tax deduction, so long as you use the loan to improve your home, you should be able to qualify for the mortgage tax credit.
Fixed Interest Rates
Another benefit of a home equity loan is that there is more certainty around your payments and the interest that you’re charged. Many home equity loans charge fixed interest rates. That means that the interest rate on your loan is locked in abd doesn’t change over the life of your loan.
In contrast, if you wanted to use a credit card to pay for something or even a HELOC loan, you are more likely to encounter variable interest rates on these products which can vary widely over time. That means that you could charge money onto your card or use money in your home equity line of credit only to see the interest rate increase soon afterwards.
Home Equity Loan Cons
If you’ve read the pros of borrowing a home equity loan, you might be ready to take one out and think that there are few downsides. Unfortunately, there are some very real downsides so you should read this section carefully before filling out that quick online application for a home equity loan.
May End Up Owing More on Home Than It's Worth
One of the most important downsides is that your home equity loan could contribute to your being underwater on your home. Now, that doesn’t mean that you’ve gone scuba diving. What it means is that you could end up owing more on your home than your home is actually worth.
Just because your home might have gone up in value after you bought it and created equity that you can tap with a home equity loan doesn’t mean that that equity is guaranteed. Real estate markets go up and also sometimes come down. If you borrow against your equity and your home loses value, you might end up owing too much on your mortgage and your home equity loan combined.
That’s a problem if you suddenly want to sell your home, either because you want to move or because your payments have suddenly become too expensive. In that case, in order to sell your home and close up your mortgage and your home equity loan, you have to take money out of your savings to make up the difference.
Fees & Closing Costs
That’s also an important consideration given that many home equity loans have a number of fees and closing costs. These include application fees, maintenance fees, closing costs, documentation fees, appraisal fees and a whole host of other potential fees. While they might not seem expensive when they’re spaced over the life of the loan in the APR rate that is calculated, if you sell your home two years into a 20 year home equity loan then those upfront fees represent a much higher percentage charge. If you do get a home equity loan, make sure to get one with low or no fees.
Putting Home at Risk
One key downside of a home equity loan is that if you are unable to pay your loan, the lender could potentially foreclose on your house. That is the last thing that you would want. For that reason, its important to be very careful before taking on loans that you’re not sure you’ll be able to manage. You might think that you want a home equity loan to pay for a renovation, new car, or fancy trip, but you will regret it if the result is that you lose your home.
Best Home Equity Loan Companies
Discover Home Equity Loan Review
For many consumers, when they hear the name Discover they might think of the Discover Card and its popular cash-back feature. But this diversified financial company offers many products. Along with its credit cards, it also features banking, home equity loans, personal loans, student loans, and gift cards.
Discover Home Equity Loan Pros
Consumers can take out home equity loans between $35,000 and $150,000 with no origination fees. The process to obtain funds is conducted online but it comes with access to a U.S.-based personal banker who is a phone call away after the information has been submitted.
Quick Online Process
After processing the initial online application, loan options will come back shortly with the request for requisite documents and information. This allows consumers to complete the process relatively quickly either online or by mailing in the documentation. The approval time will vary.
Fixed Rates, Varying Repayment Terms
The loans have fixed rates and a choice of repayment terms including 10-, 12-, 15-, 20- or 30-year plans. Consumers can choose the term that will work best for them. Discover likes to note that “no matter what,” consumers will receive a low rate.
Fixed rates currently start at a 4.99% APR, with Discover pointing out this rate is better than an average credit card’s 16.75% APR. For borrowers with good credit, Discover might be a good option thanks to the low rates and flexible terms. This can allow for lower monthly payments as well as the waiver of origination and application fees.
Potential Cost Savings
Since a home equity loan is a secured form of debt, its average interest rate will usually be lower than what will be paid on the average unsecured debt product such as a credit card. Interest payments may also be tax deductible, depending on how the loan is used, so it’s important to ask a tax advisor about this potential benefit.
Zero Closing Costs
There are no closing costs because consumers don’t have to pay application fees, appraisal costs, or mortgage taxes.
Discover Home Equity Loan Cons
Unsuitable for Short-Term Expenses
The loan isn’t well suited for paying short-term expenses. However, it can be used for consolidating debt, improving your home, paying for a wedding, refinancing your mortgage, paying for major expenses, and paying education costs.
Greater Debt
There is a cycle of debt that comes with taking out a home equity loan. After spending time to pay off debt and build equity in a home, money is now being taken out and borrowed against it. If a consumer already has debt to begin with, they can become further behind with additional debt.
Therefore, consumers should be mindful of why they are really taking out the home equity loan in the first place.
High Credit Scores Preferred
For consumers with lower credit scores, this home equity loan might not be your best option. Discover has a stated minimum credit score of 620; however, the stronger the credit you have, the better your chances of getting approved and having a lower interest rate.
PNC Home Equity Loans
PNC is a large and diversified financial services company centered around consumers and communities with a local focus. The company seeks to empower its clients with financial success. It has a full range of banking products for consumers, retail and business banking, as well as specialized services for corporations and government entities. Consumers have credit cards, banking products, and services to choose from, as well as student loans and home equity loans.
Home Equity Installment Loan Pros
Varying Loan Amounts
For borrowers, a home equity loan can be used for debt consolidation, large home renovations, and big one-time purchases.
PNC Home Equity Loan amounts start at $1,000, but they use a maximum loan-to-value (LTV) limit for borrowing. The maximum LTV is 89.9 percent, but the requirement could be lower depending on the property’s location and loan scenario. Borrowers need to know three things when determining how much they can borrow:
- Home value
- Sum of all mortgage loans on the property
- Maximum LTV established by the lender
Here’s an example with a home carrying a $450,000 value and a maximum LTV at 89.9 percent. The property has $320,000 in mortgage loans already owed on it. By multiplying the $450,000 home value by the 89.9 percent LTV, the maximum borrowing amount will be $404,550. Now subtract the $320,000 loan to determine the remaining equity; the borrower could receive up to $84,550.
Minimal Costs
There is no application fee. The closing costs are minimal and include the following:
- Recording and Satisfaction Fees: Fee determined by location
- Insurance: Borrowers are required to have insurance on the property that secures the account. Flood insurance and title insurance might be required. This is for loans of $500,000 or more, and for loans of lesser amounts depending on factors including the way the owner acquired the property. Payments on this account do not include taxes or insurance
- Property Search Fee: $12 to $250 (only in AL, IN, GA, KY, MO, NC, NJ, OH, SC, and WI)
- Residential Mortgage Act Fee: $10 in Georgia only
Interest Discounts
The loan comes with a 0.25% interest rate discount when monthly payments are automatically deducted from PNC checking accounts. The discount is also applicable when keeping automatic payments on a new checking account.
Standard Fixed Rates
The loan terms have a standard fixed rate for the loan’s life, up to 30 years. After borrowing a specific loan amount with this fixed rate, there’s a fixed, equal monthly payment that includes principal and interest. Borrowers might also have the ability to lower their monthly payments, decrease their interest expense, or pay off their mortgages earlier.
Tax Benefits
The interest paid might be tax deductible; however, interest on home equity loans/lines that are home acquisition debt are not tax deductible.
Home Equity Loan Cons
Servicing Fee
This loan comes with the following servicing fees:
- Late Charge: $40 or 10 percent of the total amount of the payment – whichever is higher
- Return Payment Fee: $30
These fees could add up if borrowers find themselves in financially challenged circumstances.
Other Options Available
PNC does have additional home equity products, but they can come with higher monthly costs and interest. They include the Choice Home Equity Line of Credit (good for accessing funds for large expenses, now and in the future) and the Home Equity Rapid Refinance (lower-cost option for refinancing a mortgage or accessing home equity).
LendingTree Home Equity Loan Review
The first thing you need to do if you’re thinking about getting a home equity loan is find a home equity loan that is right for you. The good news is that you can apply online for home equity loans these days! The bad news? Even if every lender’s online application only takes a few minutes of your time, that time adds up if you repeat the process on the websites of multiple lenders in order to compare their rates.
About LendingTree
That’s why websites like LendingTree act as loan marketplaces or online loan brokers allowing you to get and compare home equity loan offers from many different lenders by filling out just one quick online application. Why waste your time filling out the similar applications over and over again when we all know you would much rather be binge watching your favorite TV show on Netflix?
LendingTree's Offerings
LendingTree was founded in 1998 and has helped over 30 million borrowers get quick quotes for loans. They are partnered with a number of different lenders across their platform including companies like Insight Loans, J.G. Wentworth Home Lending, CBC National Bank, First Midwest Bank, Amerisave Mortgage Corp, First Direct Lending, Wyndham Capital Mortgage and many others. The breadth and scope of their lenders means that you’re likely to find one who will lend to you no matter what your personal financial and credit situation.
Interest Rates
The rates of their partners start at as low as just 4.09% and their maximum term lengths are up to 20 years. Some of the lenders on their platform charge things like an application fee, a maintenance fee, a closing fee, an origination fee and other fees on their home equity loans. But others on their platform do not so to properly compare one to another you need to read the fine print when to make sure you’re choosing the best deal.
Borrowing Limits
LendingTrees lenders require that you keep a 20% buffer of home equity, which means that any other loans or mortgages against your property and the home equity loan you’re applying for can only add up to 80% of the total appraised price. Some lenders will let you borrow as much as 90% of the total appraised value. So, if you want a loan that allows you to borrow more, you might have to look elsewhere.
To Consider
Another thing to remember is that LendingTree has a lot of lenders as partners – but there are still many partners who are not within their umbrella. For that reason, it makes sense to look into other home equity loan marketplaces or individual lenders to make sure that you’re getting the best rate. This could be especially important if you have bad credit as it can be more difficult to borrow and qualify for a great rate.
Another downside of LendingTree is that just because you’ve filled out their online application, that doesn’t mean that you’re done with your application. Once you figure out which lender you want to go with, you also have to complete their application. At this point, you could find out that you don’t actually qualify for their loan or that the rate that they can offer you is actually higher than originally quotes. For this reason, you might not save all the time you thought you would be using LendingTree.
Citizens Bank Home Equity Loans Review
About Citizens Bank
Citizens Bank is a US bank that provides a full line of loans, mortgages, checking and savings accounts, and other financial products. It’s headquartered in Providence, Rhode Island and is the 20th largest bank in the US. They primarily operate in Connecticut, Delaware, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island and Vermont.
Citizens Bank's Offerings
Citizens Bank has three different home equity products that offer great rates and terms: their Home Equity Line of Credit (HELOC), their Home Equity Loan, and their 10-Year First Lien Position Home Equity Line Loan. Each type of product is aimed at different consumer needs and which is right for you will depend on why you’re taking out your loan and what you need it for.
To apply for all of Citizens Bank home equity products, you need to fill out an online or in-person application. A home appraisal is needed and while you will likely hear whether or not you’re approved rather quickly, it can take between 30 to 45 days to close on a Citizens Bank home equity loan or line of credit.
Home Equity Loan
Citizen Bank’s home equity loan has no annual fees, application fees, or closing costs. They offer a fixed interest rate and a fixed monthly payment.
The interest rates and APR on their Home Equity Loan vary according to your personal financial and credit situation as well as where you live. If you lived in New York state, the fixed APR for a 10 year home equity loan for $10,000 to $49,999 start at 6.49%, the rates for a loan between $50,000 and $99,999 start at 5.24%, the rates for a loan of $100,000 to $399,999 start at 4.99% and finally the rates for loans over $400,000 start at 5.24%.
10-Year First Lien Position Home Equity Loan
This is a unique product in that it’s a loan for those who don’t have a mortgage or another type of lien on their property. Many people might use this home equity loan to pay off an existing mortgage.
The rates vary according to your personal financial situation, but in New York State, they begin at 5% APR with no variation according to the amount borrowed. The minimum amount you can borrow is $50,000 with a maximum loan-to-value ratio of 80%. They charge no closing costs.
This loan also takes 30 to 45 days in order to close.
To Consider
Despite the fact that Citizens Bank loans are generally good deals with low fees, there are some drawbacks. The first is that you might be able to qualify for lower interest rates elsewhere if you have good personal credit.
In addition, the length of time it takes to close on your home equity loan or line of credit from Citizens Bank might be too long if you need the money quickly.
Another drawback is the fact that you often need to borrow more in order to qualify for a lower interest rate. If you need to borrow less money, you might be better off finding a different lender who provides lower rates for smaller loans. In addition, the minimum loan amounts are quite high and so aren’t perfect for someone looking for a smaller home equity loan.
Fixed Rates vs. Variable Rates
What Are the Most Common Rates on Home Equity Loans?
Fixed rates are interest rates that don’t change over the life of your loan. In contrast, variable rates can fluctuate as the prime interest rate increases or decreases over the life of your loan. That means you could end up paying significantly more or less in interest if there is a huge change in the interest rates. Typically, variable rate loans have lower rates when interest rates are low than you would find on fixed rate loans. For that reason, they might seem more attractive.
While lenders offer both fixed and variable rate loans on home equity loans, the majority of home equity loans are fixed rate loans. Similarly, the majority of home equity lines of credit are variable rate loans.
What Kind of Rate is Best for You?
For every season there is a reason – goes the old song. Fixed rate and variable rate loans might be better choices depending on things like what the interest rate environment is like, and how quickly you intend to repay your debt.
If you are borrowing money when interest rates are low, then you’re better off to get a fixed rate loan. That’s because the interest rates are likely to increase over the life of your loan if you get a variable rate loan. By choosing a fixed rate loan, you might pay more initially, but you’ll save on interest over the life of your loan if rates go up and you’ll have a guarantee on how much you’ll pay rather than having to watch the interest rates.
There is one big exception to this rule. If you’re borrowing money for a very short period of time and plan to repay that money within a few months or less than a year, you could be better off taking the lower variable rate since interest rates might not go up enough to make a huge difference and you could end up paying less. The difficulty here is that you’re taking on more risk and so you shouldn’t get a variable rate loan if you can’t afford to repay your debt if there were fluctuations in interest rates. The last thing that you want to do is put your home at risk.
In contrast, if interest rates are currently high, you’re better off getting a variable rate loan. That’s because a fixed rate loan would mean that you would lock yourself into high monthly payments and high rates over the life of your loan. Meanwhile, lending rates could go down significantly and you could end up paying more than you need to. However, nothing is certain and even if interest rates are high, they could still go up. If you can tolerate the risk, then you could be better off with a variable rate loan.
How Does Term Length Impact the Rate You Receive?
With a home equity loan, you have to choose a term length or the length of time that you will have to repay your loan. The longer you stretch your payments out over, the less you will pay on a monthly basis, but you’ll end up paying more interest over the life of your loan. Term lengths for home equity loans can range from a couple of years to 30 years. That said, home equity loans tend to be for 10 years. Depending on the lender, you might get a discount on interest rates if you take out a longer termed loan.
Short-term home equity loans of less than 10 years are best if you’re borrowing smaller amounts that you can easily repay over a shorter period of time. The loan might be for something like a car or to top up the financial aid your kid receives at college. Before you take out a short-term home equity loan, make sure you can afford to pay the monthly payment as they will be higher than if you took out your loan for a longer period of time.
Longer term loan terms are better if you’re taking out larger amounts because that can make borrowing more affordable by lowering your monthly payment. You might use these types of loans to pay for major renovations or to refinance debt.
Now, just because you take out a home equity loan with a long term, doesn’t mean you have to take the full term to repay it. If the lender doesn’t have pre-payment fees, you could take out a longer term home equity loan to access the lower rates offered on such loans and aggressively repay your debt by paying extra each month.
Tips for Finding and Getting the Best Rates
Shop Around
While all banks and lenders compete to attract the best customers and provide the best rates, there can be huge differences between one bank or lender and another. Even a smaller difference of one or two percent can have a huge impact on the cost of your loan over the life of your loan. That’s why it’s critical to get quotes from more than one lender.
In addition, it’s important to take into account the different fees charged by different banks and lenders. They can also vary widely. Some lenders might not charge closing fees at all while others will charge 3% to 4%. That will add significant costs to your loan and could make it prohibitive and costly.
Does that make you want to get as many quotes as possible? One caveat is to make sure that the lenders that you’re getting quotes from are not performing hard credit checks. If you do a number of hard credit checks, your credit score could decrease temporarily. Since there are many lenders who provide you with a quoted estimate of your interest rate with a soft credit check, it shouldn’t be a problem to find lenders who will do so.
Improve Your Credit Before Applying
If you don’t have ideal credit, you might want to work to improve your credit before applying to increase your chances of being approved and of getting a good rate. If you can put off the loan, waiting just six to 12 months can make a significant difference on your interest rate and the cost of your loan. The best way to improve your credit is to make consistent on-time payments. This will establish that you’re a responsible borrower.
If you’ve had issues with credit in the past because you’ve gone bankrupt or you’re defaulted on a loan, the good news is that most of these negative marks on your credit are taken off your report after 7 years.
If you’re in a hurry to apply for a loan, things become more difficult. Unfortunately, improving your credit significantly can take time. But there are a few tweaks that you can make to improve your credit over a shorter period. One thing to watch out for is your credit utilization percentage. Ideally, you want it to only be using 20% to 30% of your available credit at any one time. That includes all your credit, but also your limits on each individual card.
So, if you have a $10,000 limit on your card, you should never charge more than $2,000 to $3,000 on that card – even if you pay it off at the end of the month. If you consistently charging more than that, you should either apply for a credit limit increase or space your spending over more than one card.
Be Cognizant of Changing Interest Rates
Interest rates might have been low for an extended period of time, but they’re always fluctuating. Sometimes these fluctuations are related to changes in the prime rate, but sometimes banks simply have promotions and compete with each other to have lower rates. By ensuring you pay attention to the changes in interest rates, you’ll be able to pounce on a great deal as soon as you see it.
You should also pay attention to when the Federal Reserve makes rate announcements. Generally, they make announcements once per quarter and it’s anticipated that they will continue to increase interest rates.
Home Equity Loans vs. Home Equity Line of Credit
What Are the Differences?
Home equity loans and home equity lines of credit have a lot of key similarities. The most important one is that they use their home equity as security in order to get you a lower borrowing rate. That means they’re more attractive than many personal loan options. Because of this, you are more likely to qualify for one of these types of credit vehicles since the lender has more security and you’re also more likely to qualify to borrow more. In addition, the interest you pay on the money that you borrow is potentially tax deductible.
After that, however, there are a number of key differences between a home equity loan and a home equity line of credit. A home equity loan is an installment loan. That means that you borrow a certain lump sum and get that amount all at once.
Home equity loans also tend to have fixed interest rates that do not change over the life of your loan. You then agree to a loan term over which you promise to pay back the full principal. Your loan payments are then spaced over that term in monthly amounts that are the same every month – unless you have a variable rate loan and then your payments will change according to fluctuations in the interest rates. But with a fixed rate home equity loan, you’ll pay the same amount during your first payment and your last.
In contrast, a HELOC loan works similarly to a credit card in that it is a revolving credit product. That means that you might be approved for $10,000 on your line of credit, but you might only use $5,000 to pay for a kitchen renovation. You can then pay that back according to a formula similar to your credit card that requires you to make a monthly minimum payment and then you can borrow money again or at any point while paying it off you could have used the additional $5,000 in available credit. Usually, home equity lines of credit have draw periods where you can use the line of credit and repayment periods. The typical length of a draw period is 10 years. You can see more pros and cons of HELOCs here.
The payments for your HELOC loan will vary depending on how much of your credit you have used on the line of credit. They will also vary according to the interest rates as many home equity lines of credit have variable interest rates. The amounts you pay are not amortized over a term length which means that you will pay more when you owe more and pay less as your debt decreases. It also means your payments won’t be the same each month so you’ll have less of an ability to plan your budget around paying your home equity line of credit.
When and Why Would You Want to Use a Home Equity Loan?
A home equity loan is perfect for someone who wants to get a big lump sum and pay it back over a longer period of time. Because you can choose the term length on your home equity loan, it could potentially have more affordable monthly rate than taking out a home equity line of credit which could require you repay your loan at a faster rate. Each HELOC loan has a different repayment formula, but they often expect the borrowed amount to be repaid in full faster than if you took out a 20-year home equity loan.
It’s also ideal if you don’t need to borrow money again after paying back your debt. If you have a big renovation project where all the expenses are likely to come at around the same time, a home equity loan is perfect for that. Also, if you are making a big purchase or using it to refinance debt, then a home equity loan is likely to be the better fit for you.
Another reason to get a home equity loan instead of a home equity line of credit is if you’re on a strict budget and you want to have predictable payments. Getting a fixed interest rate with your home equity loan will allow you to plan financially for other things in your life rather than having the unpredictability of not knowing how much you’ll owe on your line of credit in the future or having to anxiously watch rate changes.
When and Why Would You Want to Use a Home Equity Line of Credit?
A home equity line of credit is more ideal for someone who wants access to a significant amount of money, but might be using it over a longer period of time. You have more flexibility with a line of credit to borrow money, pay it back and borrow it again. If you just want to borrow the money to pay for purchases or expenses over a longer period of time you’ll save on interest by getting a HELOC loan over a home equity loan since you won’t have to take the money in a lump sum and so won’t have money sitting around that you’re paying interest on that you haven’t yet put to work.
For example, this flexibility is ideal for people who want to complete a home renovation slowly over many months. Perhaps you want to do it yourself to save on labor costs, but need help paying for materials. A home equity line of credit will allow you to only take out money as you need it. It’s also ideal for other purchases over a longer period of time like to help supplement your savings during a maternity leave, or to pay for tuition when helping your kids through college. Some people use a home equity line of credit as a financial backup in addition to their emergency fund. They get approved for one and use it only if something unexpected happens. It’s better than using a credit card for emergency purchases.
Others use a home equity line of credit in place of a credit card to help finance and fund everyday purchases. Because the interest rates on home equity lines of credit are so much cheaper than credit cards they will save money over time.
A HELOC loan might be better for smaller purchases as well since the minimum payments might be too much if you borrow a significant amount of money. These payments are structured differently depending on the lender. Some only make you pay interest payments in the first 10 years of your loan and then make you pay towards the interest and the principal after that. That could be affordable for now… but might not be later.
Survey of Home Equity Loan Borrowers
To get a better understanding of how consumers view home equity loans, we surveyed 1,000 Americans who were home equity loan borrowers. In January 2018, we administered a 15-question survey designed to better understand the perspective of current consumers who are currently borrowing money via a home equity loan.
Notice: this article was published on February 1st, 2018. After the publication of this survey, on February 21st, 2018 the IRS advised taxpayers that in some cases they can continue to deduct interest paid on home equity loans. Specifically, you may still be able to get the deduction if the loan is used to buy, build or substantially improve the taxpayer’s home that secures the loan.
1. Which of the following correctly describes how the new tax code impacts the treatment of home equity loans?
a. 19.70% of respondents answered "The new tax code will not impact the treatment of home equity loans."
b. 25.40% of respondents answered "Advantageous to home equity loan borrowers by increasing the proportion of interest deductible."
c. 8.80% of respondents answered "Disadvantageous to home equity loan borrowers by increasing the proportion of interest deductible."
d. 8.50% of respondents answered "Advantageous to home equity loan borrowers by decreasing the amount of interest deductible."
e. 4.40% of respondents answered "Disadvantageous to home equity loan borrowers by eliminating the borrower's ability to deduct interest costs." (Correct) note: see above guidance.
e. 33.20% of respondents answered "Unsure"
2. Which of the following following best describes why you borrowed money using a home equity loan?
a. 52.20% of respondents answered "I used a home equity loan for home improvement projects."
b. 23.30% of respondents answered "I used a home equity loan for debt consolidation (ex. credit cards, student loans, etc.)."
c. 2.30% of respondents answered "I used a home equity loan to pay for a vacation."
d. 8.60% of respondents answered "I used a home equity loan for cash in an emergency situation."
e. 3.20% of respondents answered "I used a home equity loan to pay for medical expenses."
f. 0.80% of respondents answered "I used a home equity loan to pay for a wedding."
g. 9.60% of respondents answered "Other"
3. (If B to Q2) What types of debt did you consolidate using a home equity loan? Select all that apply.
a. 75.54% of respondents included "credit card debt"
b. 39.49% of respondents included "student loan debt"
c. 37.77% of respondents included "auto loan debt"
d. 39.06% of respondents included "personal loan debt"
e. 27.47% of respondents included "Other types of debt"
4. (If B to Q2) What was your primary motivation for consolidating debt with a home equity loan?
a. 55.79% of respondents answered "I wanted to save money by getting a lower interest rate."
b. 33.91% of respondents answered "I wanted to make managing multiple forms of debt simpler."
c. 8.58% of respondents answered "It was recommended to me by a financial professional."
d. 1.72% of respondents answered "Other"
5. (If A to Q2) Did the home improvements you make as a result of the home equity loan increase the value of your home?
a. 89.46% of respondents answered "Yes"
b. 3.64% of respondents answered "No"
c. 6.90% of respondents answered "Unsure"
6. Have you previously used a home equity loan to borrow money?
a. 39.80% of respondents answered "Yes"
b. 60.20% of respondents answered "No"
7. (If A to Q6) How many times have you used a home equity loan before your current one?
a. 47.74% of respondents answered "Once before"
b. 36.68% of respondents answered "Twice before"
c. 12.06% of respondents answered "Three times before"
d. 2.26% of respondents answered "Four times before"
e. 1.26% of respondents answered "Five or more times before"
8. How long have you been in your current home?
We found that the average respondent has been in their current home for 8.45 years.
9. Which of the following best describes how you view the equity in your home?
a. 43.60% of respondents answered "The equity in my home is an investment for my future retirement."
b. 24.00% of respondents answered "The equity in my home is an investment, but not critical to my retirement strategy."
c. 23.00% of respondents answered "The equity in my home will give me the ability to trade up to a bigger home in the future."
d. 4.80% of respondents answered "The equity in my home is not important to my long term financial strategy."
e. 4.60% of respondents answered "None of the above."
10. Which of the following best describes your future expectations for your home's value in 3 years?
a. 83.80% of respondents answered "My home will be more valuable in 3 years."
b. 6.30% of respondents answered "My home will be less valuable in 3 years."
c. 9.90% of respondents answered "My home's value will be unchanged in 3 years."
11. Which of the following best describes your future expectations for your home's value in 5 years?
a. 81.90% of respondents answered "My home will be more valuable in 5 years."
b. 7.80% of respondents answered "My home will be less valuable in 5 years."
c. 10.30% of respondents answered "My home's value will be unchanged in 5 years."
12. Which of the following best describes your future expectations for your home's value in 10 years?
a. 74.10% of respondents answered "My home will be more valuable in 10 years."
b. 9.40% of respondents answered "My home will be less valuable in 10 years."
c. 16.50% of respondents answered "My home's value will be unchanged in 10 years."
13. Which of the following best describes your future expectations for your home's value in 20 years?
a. 65.20% of respondents answered "My home will be more valuable in 20 years."
b. 13.10% of respondents answered "My home will be less valuable in 20 years."
c. 21.70% of respondents answered "My home's value will be unchanged in 20 years."
14. How did you find an apply for your home equity loan?
a. 29.10% of respondents answered "I learned about home equity loans online and applied online."
b. 34.20% of respondents answered "I learned about home equity loans online and applied in a bank branch."
c. 10.80% of respondents answered "I learned about home equity loans in a bank branch and applied online."
d. 17.80% of respondents answered "I learned about home equity loans in a bank branch and applied in a bank branch."
e. 8.10% of respondents answered "Other."
15. Before borrowing with a home equity loan did you research unsecured alternatives such as personal loans?
a. 67.30% of respondents answered "Yes"
b. 32.70% of respondents answered "No"
16. Have you ever been in a situation where the total liabilities against your home, first mortgage plus other debt including home equity loans, exceed the value of your home?
a. 24.70% of respondents answered "Yes"
b. 75.30% of respondents answered "No"
Insights and Graphics
Consumers Don't Understand New Tax Law Impact
As reported by CNBC, under the new tax plan, interest paid on home equity loans will no longer be deductible in 2018. The tax changes do not allow for grandfathering, meaning individuals who have already borrowed will be impacted. Previously, consumers could deduct interest paid on up to $100,000 of home equity debt.
We found that the vast majority of consumers do not understand the changing tax law. Only 4.40% of consumers could correctly identify that the tax law would be disadvantageous by removing the interest deduction. We also found that over a third of respondents incorrectly believed that the changes to the tax code would be advantageous to home equity borrowers.
Home Improvement Projects Are Most Popular
We found that 52.20% of respondents are using home equity loans to pay for home improvement projects.
And, we found that 89.46% of these consumers believe that the home improvement project increased the value of their home. Home equity loans are often the cheapest source of funding for these projects.
Interest Savings via Debt Consolidation
We found that 23.30% of respondents primarily used their home equity loans for debt consolidation. As we briefly mentioned above, home equity loans usually have lower interest rates than credit cards, student loans, personal loans, and even auto loans. By using a home equity loan for debt consolidation consumers may be able to save money by refinancing debt to a lower interest rate.
We found that 75.54% of the respondents who used home equity loans for debt consolidation used it to consolidate debt from credit cards - which can have interest rates as high as 29.99%.
Consumers Are Bullish on Home Values in the Short-Term
We found that 83.80% of our respondents believe that the value of their home will increase over the next three years. And, we found that roughly the same proportion of respondents believe that the value of their home will increase over the next five years.
However, we noticed that bullishness dropped off when we asked consumers about the value of their homes in 10 and 20 years. We found that only 74.10% and 65.20% of consumers believe that their home will be more valuable in 10 and 20 years, respectively.
Methodology
This poll was commissioned by LendEDU and conducted online by polling company Pollfish. In total, 1,000 American consumers ages 18 and up were polled. We screened for consumers who reported owning a home and who currently have a home equity loan. The poll was conducted over a two-day span from January 30th, 2018 to January 31st, 2018. LendEDU was not compensated by a third-party for running this survey.