Home Equity 101

Home Equity 101 Blog Image

Just one of the many perks of belonging to a credit union is home equity loans with good rates. These loans can be a great method of investing in your home or yourself, but before you make the decision to apply for one, it’s wise to understand the basics of how they work. We put together an overview of home equity loans that cover the basic questions you might have about what they are and how they work.

What is home equity?

Put simply, a home’s equity is the non-mortgaged portion of your home’s value.

You can determine how much equity you have by taking the current market value of your home and subtracting the mortgage(s) owed on it.

Home Equity Loans

What are they? A home equity loan allows you to borrow against your home’s equity. It’s often referred to as a “second mortgage,” and it comes in two main types: a home equity installment and a home equity line of credit (HELOC). More on the differences between those later.

What are they used for? Home equity loans are typically used for home-related projects, like renovations and additions, but they can really be used for anything. You might use one to consolidate debt, avoid mortgage insurance on your first mortgage, pay for education or even just take a vacation. The interest on your home equity loan may even be tax deductible. (Consult your tax advisor for more information.)

How do they work? When you apply for a home equity loan, lenders will consider factors like your income, credit score and loan-to-value (LTV) ratio—which is determined by taking the amount you owe on your mortgage(s) and dividing it by your home’s current market value. Part of the approval process may require a home appraisal. After you’ve closed on the loan, you will have monthly payments.

Home Equity Installment vs. Line of Credit

Home equity installment and home equity lines of credit are the two main types of home equity loans. With an installment loan, you receive the total amount and make monthly payments based on the term of the loan. With a line of credit, you access money as needed up to an approved limit, and you have the flexibility of making minimum or interest-only monthly payments. Another difference is that that the interest rate on a line of credit is variable, while installment loans typically have a fixed interest rate. Generally, credit union home equity loans have lower rates than those from other financial institutions.

These basic points should help you decide if a home equity loan is right for you. If you’re interested in learning more about home equity loans or any other lending product, contact your neighborhood credit union. Home equity loans are just one of the many ways we help our members improve their financial situations, and we would be happy to explain exactly how they work and help you determine if it’s the right choice for you. Stop into your local branch to set up a time to meet with a team member to go over your goals and options.

Editor’s note: parts of this article were sourced from The Balance, NerdWallet and Investopedia.