Key Takeaways
A home equity loan risks your home and erodes your net worth. Don't take out a home equity loan to consolidate debt without addressing the behavior that created the debt. Don't use home equity to fund a lifestyle your income doesn't support.
The bottom line
A $50,000 home equity loan comes with payments between $489 and $620 per month now for qualified borrowers. However, there is an emphasis on qualified borrowers. If you don't have a good credit score and clean credit history you won't be offered the best rates and terms.
Higher Interest Rates:
In general, home equity loans often come with higher interest rates compared to primary mortgages or other types of secured loans. One reason for this is that home equity loans are often in the second lien position, meaning they are subordinate to the primary mortgage.
As long as you make payments on-time, a HELOC will typically not hurt your credit. While you will have a hard inquiry added to your credit report when you apply for your HELOC, the effects of this are usually short-term. Those with a robust credit profile might not even see a material impact from the hard inquiry.
Advantages of using home equity loans or HELOCs to pay off debts include the streamlining of payments and lower monthly payments (compared to credit card bills, especially). Putting up your home as collateral and diluting your ownership stake are disadvantages of using home equity for debt consolidation.
What is a disadvantage of taking out a home equity loan? Failure to repay could result in the loss of your home.
Home Equity Loan Disadvantages
Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score. If you default on the loan, the lender can take possession of the home through a foreclosure.
Interest rates are already lower than many alternatives
If you need money now, then this is likely your best option. That's because interest rates on home equity loans, averaging around 8.40% right now, are already much lower than some popular alternatives.
The main disadvantage to equity financing is that company owners must give up a portion of their ownership and dilute their control. If the company becomes profitable and successful in the future, a certain percentage of company profits must also be given to shareholders in the form of dividends.
Based on those repayment terms and rates, here's how much you can expect to pay each month on a $100,000 home equity loan: 10-year fixed home equity loan at 8.50%: $1,239.86 per month. 15-year fixed home equity loan at 8.41%: $979.47 per month.
While home loan interest rates overall have risen dramatically since 2022, HELOC rates still tend to be lower than those on credit cards and personal loans. If you qualify for the best rates, a HELOC can be a less expensive way to consolidate debt or finance a home renovation.
Calculating the monthly cost for a $50,000 loan at an interest rate of 8.75%, which is the average rate for a 10-year fixed home equity loan as of September 25, 2023, the monthly payment would be $626.63. And because the rate is fixed, this monthly payment would stay the same throughout the life of the loan.
Home equity loans use your home as collateral. You could lose your home if you can't keep up with your loan payments. Home equity loans should only be used to add to your home's value. If you've tapped too much equity and your home's value plummets, you could go underwater and be unable to move or sell your home.
Yes, there are options other than refinancing to get equity out of your home. These include home equity loans, home equity lines of credit (HELOCs), reverse mortgages, sale-leaseback agreements, and Home Equity Investments.
Depending on which situation applies, lenders cannot issue them a home equity loan until they either earn additional equity in their home or pay off some of their existing debts. Another common issue you might run into is having a credit score or payment history not meeting a lender's requirement.
These credit lines gained popularity in the 1980s due to high home appreciation and tax reform initiatives, but the Great Recession and housing crisis of the mid-2000s caused HELOCs to no longer be offered by big banks because home equity was difficult to determine.
Home equity loans ideally should be used to finance home improvements or consolidate debt at a lower interest rate — but not to cover holiday, vacation or everyday expenses, buy a car, or invest.
Debt-to-Income Ratio
Your potential lender will look at your regular income in comparison to your existing debt. If your debt outweighs your monthly income, then you'll have problems qualifying for a home equity loan. While you may qualify, you may not qualify for the amount that you prefer.
Paying off your home equity loan early is a great way to save a significant amount of interest over the life of your loan. Early payoff penalties are rare, but they do exist. Double-check your loan contract and ask directly if there is a penalty.
If, for whatever reason, you are unable to repay a home equity loan, the lender may choose to foreclose on the house that you used as collateral. The creditor's actions usually depend on the value of your home, whether there are any other liens against it, and how much money you still owe.
When you take out a home equity loan, the lender approves you for a loan amount based on the percentage of equity you have in your home (among other factors). You'll receive the loan proceeds in a lump sum, then repay what you borrowed in fixed monthly installments that include principal and interest over a set period.
Home equity financing offers more money at a lower interest rate than credit cards or personal loans. Some of the most common (and best) reasons for using home equity include paying for home renovations, consolidating debt and covering emergency or medical bills.
The Bottom Line. Home equity loans are secured against a home, so homeowners cannot borrow more than the value of the equity they hold in their home. Equity is the value of your home minus the amount owed on a first mortgage plus other liens. Lenders may lend you up to 80% of this value.
A home equity loan often comes with a lower interest rate than other loans since your home is secured as collateral. This type of financing also typically offers more money all at once than personal loans or credit cards, which may be useful if you only need to make a one-time large purchase. There may be tax perks.