Are home equity loans worth it? We dive into the details of home equity loans here to discuss all of their pros and cons. After reading this guide, you’ll be better informed about these special types of equity loans and if they’re a good option for your family.
Home equity explained
Home equity is the amount of your property you own outright and is calculated by taking your remaining mortgage balance away from the current value of your property. You must use the current market value rather than the price you paid for the property, which may have changed significantly due to inflation and many other factors.
For example, if your property is worth £200,000 and you’ve got a remaining mortgage of £150,000, then your home’s equity is £50,000. The amount of equity you have will continue to increase as you make monthly payments on your mortgage, and it could increase if the property goes up in value. Your equity can decrease if the property loses value.
What is a home equity loan?
A home equity loan is a type of loan determined by your home equity. Lenders will typically offer a loan up to 80% of your equity (loan to value ratio), subject to financial assessments and a credit score check. This means having £50,000 equity could get you a loan amount of up to £40,000. You are not restricted on what you spend the funds on in most cases.
But there are other things you need to know…
How does a home equity loan work?
Home equity loans are available from banks, building societies and online lenders. You can search your options and apply online. Once approved, you’ll receive a lump sum and then need to make fixed monthly payments until the loan balance and interest is cleared. They are not the same as a second mortgage.
The lender uses the equity in the home as collateral, so if you don’t pay your agreed monthly payments, they could force you to sell the property to get their money back. This is known as foreclosure.
These types of loans usually include a fixed rate of interest, meaning you’ll have fixed monthly payments and know exactly what will be repaid. Even better, they typically provide lower interest rates than unsecured personal loans – but not always and it’s recommended to check all options.
What is a home equity line of credit (HELOC)
A home equity line of credit, also known as a HELOC for short, is similar to a home equity loan with some key differences.
The first difference is how the money is paid out. Instead of receiving a lump sum and making repayments thereafter, you receive a line of credit you can access over many years known as a draw period. You draw money out in a similar way to taking money from credit cards. Once the draw period ends do you start to pay back the debt.
The other difference between a home equity loan and a HELOC is the interest rates. The latter has a variable interest rate that goes up and down over the repayment period.
Can you lose your house with a home equity loan?
Using a home equity loan or a HELOC puts your home ownership at risk. If you do not meet the repayment terms of the loan and pay back what you owe in full, the lender can recover the funds by forcing you to sell your home in a process called foreclosure.
However, in this situation, the lender is more likely to try and find a solution first. They could offer to reduce your loan repayments to make them more affordable, but simultaneously extend the repayment term so you pay more back. It’s still a better option than losing your home.
The benefits of a home equity loan
The generic benefits of a home equity loan are:
- You’re able to borrow larger amounts than a personal loan or credit card. While most personal loans from a bank or online lender will let you borrow up to a maximum of £25,000, a home equity loan could let you borrow over £200,000 in some instances.
- The rate of interest on a home equity loan is highly competitive and usually better than what is achievable with other credit options – unless you have an excellent credit rating.
- A fixed interest rate helps you budget for repayments easily.
- These loans are widely available in the UK with many lenders to choose between.
What is the downside of a home equity loan?
Other than putting your home on the line, the other downside of a home equity loan is the fees. You may have to pay a fee to have your property valued by the lender, but some lenders pay for this themselves.
There are also closing costs associated with a home equity loan that can be expensive, wiping off any savings you made through their lower interest rates. The closing fee can range from 2-5% of the total equity loan value. So, if you took out a £40,000 home equity loan, you could have to pay anywhere between £800 to £2,000 to end the loan.
Is a home equity loan worth it?
A home equity loan can be an affordable alternative to accessing large amounts of credit. However, borrowers should not only consider the lower rate of interest and should take into account the additional fees they will have to pay.
There is no blanket answer to say if a home equity loan is worth it or not. It will come down to personal circumstances and what type of loan you have been offered.
More home equity loan FAQs answered!
This guide has provided a general introduction to home equity loans and some key considerations before taking one out. Borrowers should weigh up all the pros and cons before deciding and consider these loans against other options.
There are further ways to tap into your home equity and many unsecured credit options available. Do your research before settling on a solution, and search more about home equity on MoneyNerd!