How to Use a Home Equity Loan
The equity in your home is the difference between how much your home is worth and how much you still owe on your mortgage. And in a metro area like Seattle where we’ve seen home values increase year over year, a home equity loan is a great way to pull existing value from your home—creating more financial flexibility for you. Whether you want to remodel an outdated kitchen or plan your dream European vacation, there are many ways you can use your home equity loan.
But before you start charting out your river cruise down the Rhine or carefully selecting that Viking stove for your chef’s kitchen, remember that any loan comes with a risk. Just like the first rule of credit cards, taking out a home equity loan requires that you know yourself and your financial goals. It’s important to ask yourself: Is this home equity loan going to make my financial life easier, or is it going to create a financial hardship? Once you’ve considered these questions, you can decide if a home equity loan is right for you.
The “fill in the blank” loan
Because you can use a home equity loan for anything, we often call them “fill in the blank” loans. The options for how you use your home equity loan are vast. From remodeling or renovating to landscape design or adding square footage, a home equity loan is a great option to invest in projects that will add value to your home. Home equity loans even give you the ability to consolidate debt.
Let’s say that you’re paying your student loans down at 6%. You may be able to—based on your credit—use your home equity loan to pay down college debt at a lower rate, saving you money in the long term. A home equity loan—while not nearly as liquid as an emergency fund—can function in part like a safety net for those larger emergencies like a flooded basement or an unexpected surgery. Home equity loans can also be used to help you celebrate the more meaningful moments in life. Weddings are pricey, and a home equity loan might ease the burden of paying for an over-the-top party with 125 guests.
Value up, equity out
Home equity loans work on the premise that your home is increasing in value; that it’s worth more money now than when you purchased it—whether you’ve paid down your mortgage in part or the market has increased its worth. The loan allows you to use your home as a point of collateral to borrow money as a fixed-rate installment loan (not unlike a car loan). You borrow the money in one lump sum and you make even monthly payments over the term of the loan—which typically lasts five to 15 years.
Understanding a home equity line of credit
An alternative to the home equity loan is a home equity line of credit, or a HELOC. A HELOC works much like a line of credit, but with a few important distinctions, including that HELOCs have variable rates whereas a home equity loan has a fixed rate for the life of a loan. Just like a credit card, the interest rate of a HELOC can change over time with the market. This is an important consideration—depending on the environment, having a fixed or variable loan could be the deciding factor of which product to choose.
There are two parts to a HELOC: the draw period and the repayment period. The entirety of the loan is typically 25 years, split between these two periods. Draw periods usually last an average of five to 10 years, while the repayment period lasts another 10 to 15 years.
Once you’ve qualified for and secured a HELOC, your draw period begins. That means you’ll be able to draw money from the loan as you need and when you need it—just like a credit card. During the draw period, the minimum payment required is the interest accrued. Once the draw period ends, you start the repayment period, where you begin to repay both principal and interest on your home equity loan.
Because of the structure of the loan, a HELOC could make the most sense if you’re doing a home remodel or renovation project yourself over time. You might be uncertain of the total cost of the project, so you don’t need a lump sum like you would with a home equity loan.
Whether you choose a HELOC or a home equity loan, both are versatile options that allow you to take advantage of an existing, valuable asset. From planning a dream vacation to building out your basement, a home equity loan provides the cash necessary to invest in what matters most to you and your family.