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Can You Afford That Home Equity Loan?

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You’ve worked to build up all this equity in your home, and now you want to tap into it with a home equity loan. It’s a financial move that scores of people make every day. But have you considered whether you can afford that home equity loan? You should, and here’s why.

What is a Home Equity Loan?

Also referred to as a second mortgage, a home equity loan can garner you a lump-sum payment that you repay at a fixed interest rate.

You do need sufficient equity, however. Equity is the difference between your mortgage balance and your home’s value. How do you build equity? By continuing to pay down your mortgage. Also, a rise in local real estate values will also help produce equity more quickly.

How Do Such Loans Work?

Once you get a loan, you’ll make monthly payments that will include the principal and interest over an established number of years at a fixed rate. 

The risk – and it’s a big one – is that because the loan is secured by your home, you could lose said home if you default on payments. Note, too, that you must make a second mortgage payment plus your current one.

How Much Do These Loans Yield?

In general, you can borrow about 80 percent to 85 percent of your house’s value, less your mortgage balance. You can use a home equity loan calculator, which can help you estimate the amount you may be able to borrow. A HELOC payment calculator serves this purpose as well, particularly this HELOC calculator.

What Do I Need to Get One?

This varies among lenders, but you’ll generally need 15 percent to 20 percent of home equity as well as a credit score of at least 620. You’ll also need a debt-to-income ratio – the percentage of your monthly income that goes to your debts – of no more than 43 percent. 

You also may need to have your property appraised to figure out the amount you’re qualified to borrow.

Is a Home Equity Loan Like a HELOC?

Kind of, except that a home equity line of credit (HELOC) is more flexible than a home equity loan, which provides a single lump sum.

Both home equity loans and HELOCs have a total loan amount. However, with a HELOC, which you can liken to a credit card, you borrow only the amount you need. Once you clear that debt, you can borrow again. So, you repay a HELOC in increments based on how much you use, instead of the whole loan amount.

Further, home equity lines of credit have adjustable rates that could increase and decrease over the loan’s life, which affects your payments. To start, HELOC rates are usually discounted, only to rise after six months to a year.

What are the Benefits of a Home Equity Loan?

  • You may be able to deduct the interest on your taxes – IF the loan is used for home improvement.
  • You needn’t relinquish a low interest rate on your existing mortgage
  • Your interest rate may be lower than a credit card or personal loan.
  • Payments are predictable.

What are Home Equity Loan Drawbacks?

  • If you sell your home before the loan debt is erased, your loan balance will come due.
  • Missed or late payments could result in the loss of your house.
  • Interest must be paid on the whole loan amount.
  • A home equity line of credit is more flexible.

Ultimately, you can determine whether you can afford a home equity loan by using a home equity loan calculator. Do choose wisely, since the loan is secured by your home.

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