What is a Home Equity Loan (HELOAN)?
Updated: Jan 21
Your home is your biggest asset. A Home Equity Loan (HELOAN) puts your home to work for you.
A HELOAN allows you to borrow money by using your home as collateral. A HELOAN is sometimes called a second mortgage as you can use the equity in your home – the value of your home less your mortgage amount – to borrow money. HELOANs can be used for a variety of purposes like home improvement, debt consolidation or paying for education or medical expenses. The interest rates on HELOANs are usually lower than those on other types of personal loans and the interest paid can be tax-deductible*. Let us look at an example of a HELOAN.
A HELOAN typically allows you to borrow up to the value of your home less your mortgage amount. If your home is worth $500,000 and your mortgage amount is $350,000, a HELOAN can let you borrow up to $150,000.
All the funds, in this case, $150,000, are available as soon as the loan is approved. The loan is paid down over time, usually between 5 and 30 years.
The interest rates on HELOANs depend on the size of the loan and the loan-to-value ratio. In this case, the loan-to-value (LTV) ratio is 100% as the borrower would like to withdraw their entire equity. Usually, the higher the LTV, the higher is the interest rate charged.
Let’s assume an interest rate of 10% and a loan term of 10 years. The borrower would make monthly payments for this loan of roughly $1,982 for 10 years.
Using Loan Funds
You can use your HELOAN funds for any purpose that you desire. Most borrowers use them for big expenses like:
i. Home Remodeling or Renovation – enhance the value of your home
ii. Debt Consolidation – reduce monthly payments by paying off the high-interest credit card and personal loan debt
iii. Education Expenses – pay for kids’ college or pay off student loans
iv. Healthcare or Medical Expenses – take care of family members
v. Create a Rainy-Day Fund – emergency funds to pay for life’s surprises
Advantages of Home Equity Loans (HELOANs)
HELOANs offer many advantages over other personal loans making them a superior option when borrowing money.
a. HELOANs are the Simplest Way to Borrow Against Home Equity – HELOANs are simple and straight-forward loans. Unlike HELOCs which have confusing draw terms and variable interest rates, HELOANs give you access to the entire loan amount at once and have fixed interest rates.
b. HELOANs are Cheaper – HELOANs usually offer lower interest rates and lower monthly payments than credit cards and personal loans. Using your home as collateral lowers the interest rate charged.
c. HELOANS Offer Larger Loan Sizes – The amount of money that you can borrow is usually only limited by your home equity. The loan amount is usually significantly higher than that on personal loans or credit cards.
d. Interest Payments are Tax-Deductible* – You could save money on your taxes by deducting the interest paid on a HELOAN. This deduction can lower your monthly payments further. Interest paid on credit cards or personal loans is not tax-deductible.
Disadvantages of Home Equity Loans (HELOANs)
HELOANs have some drawbacks that may not make them the best option for all borrowers.
a. Your Home is Collateral – HELOANs allow for cheaper borrowing because your home acts as security for the loan. Under extreme circumstances, if you are not able to repay the loan, your home could be foreclosed to recover the loan amount.
b. Tax Deduction May Not Apply – Tax deductions depend on various factors and do not apply to all borrowers equally. Depending on your income, state of residence, and mortgage interest you may be unable to receive any tax savings.
*Tax deductions depend on your income, mortgage interest, and state and local taxes among other factors. Please check with a tax professional to determine if your interest would be tax-deductible.