How Do Home Equity Loans Work? Your Questions Answered

In the post-COVID-19 pandemic market, interest rates have risen, and more homeowners have stayed where they are. This seller’s market, in which inventory is low, and home prices are high, has one upside: homeowners have become rich in equity.

Home equity is the difference between the current market value of your home and what you still owe on your mortgage. 

Imagine your home equity as a piggy bank filled with cash you can potentially tap into—a home equity loan can be the key to unlocking it.

Unlock Your Home Equity with Figure

• Approval in 5 minutes. Funding in as few as 5 days
• Borrow $20K-$400K
• Consolidate debt or finance home projects
• Fastest way to turn home equity into cash
• 100% online application

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What is a Home Equity Loan?

A home equity loan allows you to borrow a lump sum of cash using your home’s equity as collateral. 

Much like a traditional mortgage, you repay the loan with a fixed interest rate over a set term. This translates to predictable monthly payments throughout the loan period, making budgeting and financial planning easier.

Let’s dive deeper into how home equity loans work and how they can benefit you.

How To Get a Home Equity Loan

The process of obtaining a home equity loan generally involves these steps:

1. Shop around and compare lenders: Research different lenders to find the best interest rates, loan terms, and fees that suit your needs.
2. Apply with your chosen lender: The application process typically involves submitting financial documents such as pay stubs, tax returns, and proof of homeownership.
3. Appraisal and underwriting: The lender will order an appraisal to determine your home’s current market value and assess your financial situation to determine your eligibility and loan amount.
4. Closing: Once approved, you’ll finalize the loan details and receive the loan amount, typically in one lump sum.

Benefits of a Home Equity Loan

If homeowners are so “equity-rich,” why would they want to touch it? Home equity loans can help homeowners easily accomplish many goals by providing financing.

Home equity loans have specific benefits that other loan products don’t, including:

• Fixed Interest Rate: Predictable monthly payments throughout the loan term for easy budgeting.
• Potentially Lower Interest Rates Than Other Options: Compared to HELOCs (Home Equity Lines of Credit), home equity loans can offer lower interest rates depending on your creditworthiness.
• Access to a Lump Sum of Cash: Ideal for financing larger expenses like home renovations, debt consolidation, or educational costs.
• Tax Advantages (Consult a Tax Professional): Sometimes, the interest paid on a home equity loan may be tax-deductible (consult a tax professional to confirm eligibility).

Does a Home Equity Loan Affect Your Mortgage?

Taking out a home equity loan does not directly affect your mortgage.

Your original mortgage remains unchanged, and you’ll continue making regular monthly payments on that loan.

 However, you’ll now have an additional monthly payment for your home equity loan.

Does Taking Out Equity Increase Your Mortgage?

Taking out a home equity loan does not increase your mortgage balance.

Your mortgage represents the original amount you borrowed to purchase your home. 

A home equity loan is a separate loan secured by the equity you’ve built up in your home over time (by making mortgage payments and as the market value of your home increases).

Important Considerations Before Taking Out a Home Equity Loan

• Interest Rates and Fees: Carefully compare interest rates and fees from different lenders. A lower interest rate can significantly impact the total cost of the loan.
• Impact on Your Debt-to-Income Ratio: Taking on another loan will increase your debt-to-income ratio, which could affect your ability to qualify for future loans.
• Risk of Foreclosure: Since your home is collateral, defaulting on the loan could lead to foreclosure.
• Potential Tax Implications: Consult with a tax professional to understand the tax implications of deducting interest on your home equity loan.
• Closing costs: Fees typically range from 2% to 5% of the loan amount.

Is a Home Equity Loan Right for You?

A home equity loan can be a powerful financial tool, but weigh the pros and cons carefully.

Consider your financial goals, risk tolerance, and ability to make the additional monthly payments  Consulting with an experienced lender, matched by MyPerfectMortgage.com, can help you determine if a home equity loan is the right option for your unique situation.

By understanding how home equity loans work and carefully considering the factors involved, you can make an informed decision about tapping into your home equity to achieve your financial goals.