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by Holly Johnson
July 02, 2020
by Holly Johnson
July 02, 2020
Taking out a loan is never ideal, but it may not ruin your finances if you borrow the right way.
This usually means choosing loan options that come with low fees and a competitive interest rate, and of course making sure you're borrowing for reasons that will benefit you in the long run.
One type of loan that remains popular with borrowers is the home equity loan, also known as a second mortgage. This type of loan lets you borrow against the equity in your home, meaning it is secured by your property's value.
With a home to use as collateral, consumers are usually able to get lower interest rates than they can get with credit cards and other unsecured loans. Home equity loans come with low fixed interest rates, a fixed repayment timeline, and fixed monthly payments that will never catch you by surprise.
Home equity loans won't work for everyone since you need considerable equity to use them. Most home equity loans only let you borrow up to 85% of your home's value. This means that, if you own a property worth $300,000, you could only owe up to $255,000 on your home including your primary mortgage and your new home equity loan. Also note that since a home equity loan offers your home as collateral, in a worst-case scenario where you couldn't repay the loan, the bank would be able to foreclose on your home.
That's why, if you're considering a home equity loan to fund your goals, it's best to take a step back before you do. Borrowing for a vacation to Tahiti is generally a bad idea, but there are plenty of ways a home equity loan could leave you better off. Here are the best ways to use your home equity to your advantage.
Considering the average credit card APR is now over 17%, using a home equity loan to pay off credit card bills can be smart.
After all, some banks offer home equity loans with rates as low as 5.49%. It's not difficult to imagine how much you could save — and how much faster you could pay down debt — if you transferred high-interest credit card bills to a home equity loan with a rate that's less than a third of what you're paying on your credit cards.
If you need some numbers to chew on, here's an example:
Imagine you have $10,000 in credit card debt at 17% APR. If you made a minimum payment of $300 each month, you would spend 46 months paying it off and fork over $3,629 in interest in the process.
If you transferred that debt to a home equity loan at 5.49%, on the other hand, things look totally different. With the same $300 monthly payment, you could pay off your debt in just 37 months and pay only $875 in interest.
While credit card debt is a no-brainer for debt consolidation, don't forget you can use home equity to consolidate other types of debts. The key is choosing debts that have a higher interest rate than you could get with a home equity loan.
If you have a high-interest personal loan, auto loan, or private student loan and have a lot of equity in your home, for example, using your home equity could be smart. Consolidate all your debts with a home equity loan with low or no fees and a lower APR, and you could save big over the long haul.
Many consumers use home equity loans to make important home improvements or upgrades. This tends to make sense since you're using your home equity to improve your property, which should, in turn, boost the value of your abode.
Some home improvements tend to have a higher payoff than others. According to Remodeling Magazine's Cost vs. Value study for 2019, upgrades with the highest rate of return include a garage door replacement (97.5%), manufactured stone veneer (94.9%), and a minor kitchen remodel (80.5%).
But really, any kind of remodeling project can pay off if you personally find value in it. If you've always wanted a new kitchen and need to borrow to make it happen, a home equity loan is one of the most affordable ways to do it. Also note that if you qualify according to IRS rules, you can still deduct the interest on home equity loans when the funds are used to "buy, build or substantially improve the taxpayer's home that secures the loan."
Another way to use home equity to your advantage is by adding an addition to your home. This can work in your favor in more than one way; not only will the addition add value to your property but scoring some extra room could help you prevent a pricey move.
If you love your home but simply need more space, adding a family room, a bathroom, a mudroom, or a bedroom could help you score the square footage you need. A home equity loan can help you fund the project without tapping in your personal savings.
If you are angling to become a landlord or purchase commercial property this year, you can expect to pony up a big down payment. In lieu of tapping into your personal savings, you could use your home equity to get the cash you need. Since home equity loans are secured by the value in your property, they often offer the most competitive interest rate you'll qualify for.
You can also tap into home equity to start another business, whether that's opening a franchise or starting your own company from scratch. A home equity loan can help you access a large amount of money at once without tapping into your personal savings or taking out a pricey small business loan.
Finally, many people use home equity for emergencies, although they typically use a home equity line of credit (HELOC) for this purpose. Where home equity loans offer a fixed lump sum, a fixed interest rate and a fixed monthly payment, HELOCs work as a line of credit you can borrow against. This makes them a lot like credit cards, although with much lower rates since any monies you borrow are secured by the equity in your home.
The best part about a HELOC is that, if you don't borrow any money, there's nothing to repay. That makes them perfect for emergencies such as a job loss, unexpected medical bills, or a health scare. Just make sure to watch out for fees and compare HELOCs to find the best deal.
Are you interested in learning more about home equity loans? Contact the loan officers at Wintrust Mortgage to discuss your options.