Learning finance

Are home equity loans affordable?

There are several ways to reach your goal when it comes to paying for big-ticket items like home repairs, education, investments, or vacation properties. If you’re a homeowner, your home equity can be the golden ticket to achieving your goals. But with a home equity loan, there are costs in the form of origination fees, appraisals and interest. Are home equity loans affordable?

Key points to remember

  • Home equity loans use your primary residence as collateral for a lump sum loan that is 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 home, you accumulate equity. If the value of your home increases due to market trends, your net worth also increases.

A home equity loan is a very flexible tool – repayment terms vary from 5 to 30 years with fixed interest rates and payments. And since the loan is repaid in a lump sum, you can use it for anything you want, including home renovations, paying off higher-interest debt, or funding education.

But a home equity loan is not without cost. Since a home equity loan is a second mortgage, the fees and application process are very similar. Fees vary by lender, but generally include an appraisal fee to quantify how much equity you have, as well as origination fees which may consist of registration fees, documentation fees, etc.

Home equity loans also earn interest. Home equity loan rates are usually a bit higher than traditional mortgage interest rates. This is to protect the lender in the event of default. If you fail to make payments on your home loan or main mortgage, your home could be taken and sold by the lender to recoup its costs. In this situation, the primary mortgage is paid off first, with the excess proceeds going to the home equity loan.

Point

While home equity loans and home equity lines of credit both leverage the value of your home, 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 very subjective term. Home equity loans are unequivocally affordable compared to other forms of financing for large amounts, such as credit card cash advances or payday loans. Since their interest rates are fixed for the term of the loan, it should be easy 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 adjustable interest rates. While this can be an advantage when rates are low, when rates rise borrowers may find the revolving line of credit 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 how the funds are used. But while you can use the cash on anything, it would be wise to use it on something with a bit of a return. Using funds for improvements that increase the value of your home would be safer than using them on vacation.

Are interest rates on home equity rising?

2022 has proven to be a volatile year for mortgage rates, and they have almost doubled since last year. But while rates have gone up, they still don’t come close to the interest charged on most consumer credit cards. A home equity loan remains a more affordable way to finance projects for amounts that cannot be repaid quickly.

How much does it cost to apply for a home equity loan?

Closing costs vary from lender to lender. Some lenders may waive certain fees as a benefit, but generally you will pay for an appraisal, origination fee, document preparation fee, credit report fee, and title search. Typically, closing costs will be between 2% and 5% of your home equity loan amount. Many lenders will build these costs into your loan repayment to avoid upfront fees.

How much can I borrow on a home equity loan?

The total amount of your loan depends on the equity in your home. Most lenders will only allow you to borrow up to 80% of your total capital.

The essential

Home equity loans are flexible tools that allow homeowners to borrow large sums. With rates typically a little higher than mortgage rates but significantly lower than credit card rates, they provide affordable access to cash. Although mortgage rates are rising, they are still low enough to make a home equity loan attractive to the average homeowner.