There are a few ways to reach your goal when it comes to paying for big-ticket items like home repairs, education, or investment or vacation properties. If you’re a homeowner, the equity in your home may be the golden ticket to achieving your goals. But with a home equity loan come costs in the form of origination fees, appraisals, and interest.
Are home equity loans affordable?
- Home equity loans use your primary residence as collateral for a lump sum loan repaid on a fixed payment schedule.
- Home equity loan interest rates are tied to mortgage rates.
- Home equity interest rates are significantly lower than credit card interest rates and provide flexibility for borrowers.
What Is a Home Equity Loan?
Simply put, a home equity loan is a lump sum loan using your primary residence as collateral. As you make mortgage payments on your house, you build equity. If the value of your home goes up due to market trends, your equity also increases.
A home equity loan is a very flexible tool—repayment terms range from five to 30 years, with fixed interest rates and payments. And since the loan is paid in a lump sum, you can use it for whatever you wish, including home renovations, paying down higher-interest debt, or funding an education.
But a home equity loan isn’t without its costs. Since a home equity loan is a second mortgage, the fees and application process are very similar. Fees will vary by lender but typically include appraisal fees to quantify the amount of equity that you have, as well as origination fees that could consist of recording fees, document fees, and so on.
Home equity loans also accrue interest. Home equity loan rates are typically a bit higher than traditional mortgage interest rates. This is to protect the lender in the event of a default. If you fail to make payments on your home equity loan or your primary mortgage, your home could be taken and sold by the lender to recoup its costs. In this situation, the primary mortgage is paid first, with the excess proceeds going to the home equity loan.
While home equity loans and home equity lines of credit (HELOCs) both leverage your home’s value, home equity loans have fixed interest rates. When interest rates are volatile, a fixed rate can save money.
Are Home Equity Loans Affordable?
Affordability is a highly subjective term. Home equity loans are unequivocally affordable compared to other forms of funding for large amounts, such as cash advances from a credit card or payday loans. Since their interest rates are fixed for the life of the loan, it should be simple to judge whether your payments are manageable on your current budget.
When it comes to similar products, a home equity line of credit (HELOC) is the closest option. Compared to a HELOC, which also uses the equity in your home as collateral, a home equity loan has the potential to be more affordable. Typically, HELOCs have variable interest rates. That can be a benefit when rates are down, but when they go up, borrowers may find that the revolving line of credit is more expensive than a home equity loan.
What Can I Use a Home Equity Loan for?
You can use a home equity loan on anything. Since it is paid in a lump sum, your lender has no control over the use of funds. But while you can use the money on anything, it would be wise to use it on something with a bit of a return. Using funds on improvements that increase your home’s value would be more prudent than using them on a vacation.
Are Home Equity Interest Rates Rising?
The year 2022 has proven to be volatile for mortgage rates, which have nearly doubled since last year. But while rates have risen, they still don’t come close to the interest charged on most consumer credit cards. A home equity loan is still a more affordable way to fund projects for amounts that can’t be paid back quickly.
How Much Does It Cost to Apply for a Home Equity Loan?
Closing costs vary from lender to lender. Some lenders may waive some fees as a perk, but generally, you’ll pay for an appraisal, origination fee, document preparation fee, credit report fee, and title search. Typically, closing costs will be anywhere from 2% to 5% of your home equity loan amount. Many lenders will roll these costs into your loan payment to avoid up-front fees.
How Much Can I Borrow on a Home Equity Loan?
Your total loan amount depends on how much equity you have in your home. Most lenders will only let you borrow up to 80% of your total equity.
The Bottom Line
Home equity loans are flexible tools for homeowners to borrow significant amounts of money. With rates typically a bit higher than mortgage rates but significantly lower than credit cards, they offer affordable access to cash. While mortgage rates are rising, they are still low enough to make a home equity loan attractive to the average homeowner.