While many homeowners are currently experiencing a decrease in their home's equity due to a declining real estate market, it's important to know how you can use your home's equity wisely for important life purchases. As long as the price of your home is valued at more than the purchase price, typically 20 percent, you can take a loan out and convert your home's equity into cash to pay for just about anything. Home equity loans or lines of credit can be used to fund a child's education, pay for medical bills, do home repairs or remodeling, consolidate debt, purchase a car or even take a dream vacation.
Home Equity Loans vs. Line of Credits
A home equity loan is a closed-ended loan (also known as a second mortgage), which features a fixed interest rate to be repaid in equal monthly payments over a specified term, usually 10 to 15 years. Borrowers are using the equity in their home as collateral and the loan is secured based on the value of the property.
A home equity line of credit offers a variable interest rate, which means the rate can change. It functions similarly to a credit card in that you only pay interest on the amount you use. You can draw on your credit line whenever you want using checks, and pay a minimum balance each month.
One of the major draws of home equity loans and lines of credit is that they typically offer lower interest rates than credit cards and personal loans. In addition, the interest charged is tax deductible, similar to the interest on first mortgages. This savings advantage is why many people opt for a home equity loan or line of credit over credit card debt or an auto loan.
Borrowing on your home's equity does involve risk. With a home equity loan and line of credit, your home is used as collateral, thus there is always the danger of losing it if there's an inability to make the loan payments. Taking out a home equity line of credit for frivolous purchases could get you into trouble down the road. So you'll want to weigh the benefits as well as the possible financial strain of a new loan.
Qualifying for a home equity loan or line of credit is usually easier than for a first mortgage. However, lenders still require good-to-excellent credit history and will take into consideration your debt-to-income ratio (the percentage of your monthly gross income that goes toward paying debts).