Home ownership can be a powerful financial resource. If you're looking to make home improvements, send a child to college or reduce your monthly debt payments, you might want to consider a loan that puts your home's value to work for you.
Home equity loans and lines of credit — also called second mortgages — offer several benefits over other loan choices. Lower interest rates, income tax write-offs and flexibility have made these loans popular with homeowners.
But as with any loan, especially one using your home as collateral, home equity loans and lines of credit should be researched carefully and used wisely.
What is equity?
Equity is the difference between a home's value and what is owed on the mortgage.
If you've owned your home for a while, and the property value has increased, the equity might even be more than the total of your payments.
To estimate your equity, you can use sale listings of similar houses in your area or an online calculator. A bank will use a professional appraisal service to determine the amount.
What's the difference between a loan and line of credit?
A home equity loan is a specific amount of money borrowed against your home's equity. The loan is paid off at a fixed interest rate for a specific period of time.
A home equity line of credit, also known as a HELOC, is a bit different. The line of credit gives you access to a certain amount of money over a period of time to use as needed. The interest rate on a line of credit is variable, unlike the locked-in rate on a home equity loan.
How can I use the loan?
The money could technically be used for anything, but it is generally considered wise to use your home equity to improve your financial situation or invest in the future.
When you're applying for the loan, the bank will ask how the money will be used. The most common use of the loan or line of credit is for major home improvements that will bring even more value to the property.
Other common uses include consolidating credit card debt or paying for college tuition. This can save thousands of dollars of interest from high-rate credit cards or other loans. If you're using the money to pay off credit cards, it is important to create a new financial plan to avoid creating new debt.
It is generally advised that homeowners use home equity loans and lines of credit for practical purchases, especially those that help you gain a new asset or form of revenue.
Are there downsides to using equity?
Either a loan or line of credit can be called a second mortgage, because just like the first mortgage, the bank secures the loan or credit line with the house. Simply put, if you do not make your payments, you can risk foreclosure on your home.
Borrowing from equity also is like trading part of your home ownership for cash. With either option, the balance needs to be paid off before the house gets sold.
But with a little research, careful planning and working with a responsible lender, tapping into your home equity can be a good option for investing in the future.
Learn more about home equity loans and lines of credit offered by Regions Bank.