What is a fixed rate home equity loan and is it the right option for you? In this guide, we will explain what home equity loans and HELOCs are all about, so you can make an informed decision.
For personal advice and support, consider speaking with a free money advice group or even a commercial finance professional.
What is home equity?
Home equity is the value of your home that you own outright, often expressed as a percentage.
To work out the amount of equity in your home, you first need to know the market value of the property. This is not the same as the amount you paid for the property as the purchase price may not accurately reflect the value, especially considering values can change over time.
Once you have an accurate market value, you must then subtract your existing mortgage from the amount. So, if your home has a value of £175,000 and you have an outstanding mortgage of £90,000, you therefore have £85,000 home equity.
As you continue to make monthly payments on your mortgage, your home equity will increase providing the value of the home does not decrease.
What are home equity loans?
Home equity loans allow you to borrow a lump sum based on how much home equity you have. You then make an ongoing monthly payment to repay the money plus interest. The lender uses the equity in your home as collateral and can force you to sell the home to repay if you do not keep to the agreed monthly payments.
You will not be able to borrow an amount equal to your home equity. The maximum loan to value ratio offered is around 80%, meaning you can access around 80% of your home equity in one of these loans. For example, someone with £100,000 equity could get a loan for as much as £80,000 – if needed.
Just because you have built up equity doesn’t mean you’re certain to be approved for one of these loans either. You’ll need to make an application after careful consideration, and then the lender will assess your personal finances and credit score before rejecting the application or making an offer.
What are home equity loans used for?
These loans rarely have restrictions – if ever – on what you can use the funds for. Most people release larger amounts of equity to complete home renovation projects, such as loft conversions, conservatory extensions or other substantial home improvement projects. These are beneficial because they can simultaneously add value to your home and increase your home’s equity while you spend it.
Other reasons to choose a home equity loan include debt consolidation, medical and education expenses or even as a downpayment for a second mortgage on another property.
The benefits of a home equity loan
The pros of using a home equity loan are:
- Lower interest rates
These loans typically have a lower interest rate than what is offered through other personal loans. Because lenders are using your home equity as collateral, it makes it easier for them to chase you for the money if you do not repay. Thus, they can offer a lower interest compared to many credit cards and unsecured loans.
Note: This may not always be the case. If you have an excellent credit score, you might be able to find competitive rates without listing an asset as collateral.
- Bigger credit available
Depending on your home’s equity, these loans can enable you to access much larger amounts of credit than can normally be accessed through other loans. People who have nearly paid off their mortgage can get six-figure loans, whereas these are almost impossible using other loan products.
Does a home equity loan typically have a fixed interest rate?
Most home equity loan companies will provide these products with a fixed interest rate. With fixed interest, you will know exactly how much interest you are going to pay for the lifetime of the loan repayments, making it easier to budget for all your loan repayments accurately.
The fixed rate you receive will account for any drastic changes in the future, and to protect themselves, lenders often charge more than is needed to mitigate their own lending risk. Nevertheless, the rates are still lower in comparison to many other loan types.
What is the benefit of a fixed rate home equity loan?
The benefit of having a fixed rate on your home equity loan is the understanding of how much you need to repay in any situation, regardless of changes in interest rates. This should provide clarity and make it easy to work out your monthly budget.
Home equity loan vs HELOC
A home equity line of credit (HELOC) is similar to a home equity loan, but instead of receiving a lump sum amount, the homeowner gets access to an equity line of credit they can access over a draw period which can last over a decade.
Equity lines of credit work similar to credit cards; the credit line is accessed when the individual needs it. Within the draw period, it is common for only interest payments to be made, and after the draw period, the capital starts being repaid as well.
Are HELOCs fixed or variable interest?
Another main difference between home equity lines of credit and equity loans is how interest is calculated. A HELOC uses variable rates of interest that can increase and decrease during the draw period and thereafter.
Is fixed or variable interest better?
There is no easy answer to this question because it is time-sensitive. If you believe that interest rates are going to rise then it is better to lock in a lower fixed rate for as long as you believe they will rise. But if you think interest rates will go down, then a variable rate will prevent you from overpaying interest on a loan or mortgage.
What is the downside of a home equity loan?
There are two main downsides to using an equity loan. The first is that you are putting your family home at risk. Even if your financial situation is able to cope with payments, you can never be sure of what will happen in the future that may affect your personal income.
Secondly, most home equity loans include closing costs that can be significant. You might have to pay a one-off fee at the end of the loan equal to between 2% and 5% of your total loan amount. Thus, if you took out an equity loan for £25,000, you might have to pay between £500 and £1,250 extra.
This additional fee may or may not wipe off any savings you would make through lower interest, and it should be factored into your decision.
What is the usual repayment period for a fixed rate home equity loan?
Home equity loans can be repaid in just a few years up to as long as two decades. The length of time you need to repay will be determined by how much equity you want to release and your personal financial situation. The time you need to repay may also have an effect on the interest rate you are offered.
Fixed-rate home equity loan calculator
Most lenders now provide a loan calculator on their website pages, including fixed-rate home equity loan calculators where applicable. These calculators can be sued to give you an estimate of how much you will be asked to repay plus interest based on the amount you want to borrow and the repayment term.
However, these calculators don’t usually include personal finances and don’t take into account credit scores. Use them for information but take them with a pinch of salt.
Where to find home equity loans (fixed rate)
Fixed-rate home equity loans are available from some banks on the high street, building societies, and online creditors. However, at the time of writing and subject to change, most lenders widely advertise home equity line of credit products more than fixed-rate home equity loans.
This might be because it is easier for the lender to offer a variable rate that changes over time than it is to plan for a long-term repayment period with a fixed rate. Even most fixed-rate mortgages are only fixed for so many months or years before switching to variable-rate mortgages.
Nevertheless, you can still find some fixed-rate options online. You might just have to dig a little deeper and go beyond Google’s first page.
Is a fixed rate home equity loan right for you?
If you have enough home equity to access one of these loans and need the funds for a specific reason then it could be a smart decision. Home equity loans can offer you large credit that otherwise wouldn’t be available and with lower interest.
But you should also consider a HELOC with a variable rate of interest. You may be able to save even more using a HELOC but it will not provide you with any guarantees and you will not be 100% sure of how the interest rate will change.
The decision comes down to personal situations and preferences, and it’s best to seek qualified advice from the outset. Some alternative options include unsecured and secured loans, credit cards, remortgaging, lifetime mortgages and reverse mortgages.
FREE home equity loan information!
Do you want more free information on home equity loans? Anyone considering one of these credit options should gather as much information as they can before making a decision. MoneyNerd provides clear answers on this topic with an arsenal of informative guides without confusing jargon. Check out more of our equity loan guides soon!