Home Equity 101

Just one of the many perks of belonging to a credit union is home equity loans with great rates. These loans offer options for investing in your home or yourself, but before you make the decision to apply for one, it’s wise to understand the basics of what they are and how they work.

What is home equity?

To begin, let’s talk about home equity. Put simply, it’s the amount of home you “own.” More accurately, it is the non-mortgaged portion of your home’s value. It’s a considerable asset that can be used in powerful ways.

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 isn’t just the amount you have paid on your home; if your home’s value has increased, perhaps because your neighborhood has become popular, you may have more home equity than the dollar amount you’ve paid toward your mortgage.

Home Equity Loans

Home equity loans are just one of the tools you can use to leverage your home’s equity. Here are answers to some common questions regarding 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.)

Is the home used as collateral for the loan?

Yes. Home equity loans use your home as collateral. That’s why it is important to talk to your credit union about a home equity loan before you take one out. Make sure you are comfortable with the amount and terms of the loan.

Can I sell my home before the home equity loan is paid off?

Yes. If your home equity loan isn’t paid off at the time you sell your house, proceeds from the sale can go toward paying it off. 

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. In a nutshell, one gives you the total amount up front, while the other allows you to draw from it up to a certain limit over a period of time. Both are good options, and often, credit union home equity loans and lines of credit have lower rates than those from other financial institutions.

Home Equity Installment

With an installment loan, you receive the total amount up front and make monthly payments based on the term of the loan. Installment loans typically have a fixed interest rate, which means your interest rate will never increase.

Home Equity Line of Credit (HELOC)

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. One benefit of a HELOC is that you only pay back, and pay interest on, the amount you use. The drawback is that the interest rate on a line of credit is usually variable, so your monthly payment could go up.

Is a home equity loan for you?

You may be wondering if a home equity loan is the right tool to help you reach your goals. If you’re on the fence, some questions you might have are:

Do I qualify for one?

Whether you qualify for a home equity loan will depend on the lender you’re obtaining it from. 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. Additionally, part of the approval process may require a home appraisal.

Is it too soon for me to get a home equity loan?

Technically, it’s possible to get a home equity loan soon after you close on the first mortgage. However, you will typically have to pay down your mortgage for several years before you build enough equity to qualify for a loan.

Is a home equity loan really a good idea?

This is a fair question. The answer is it absolutely could be, but it depends entirely on your situation. If you meet a lender’s qualifications, then a low-rate home equity loan could be an excellent option to help you renovate your home, finance tuition, consolidate high-interest debt or reach some other goal. It allows you to leverage one of your most valuable assets.

If you’re interested in a home equity loan from TruStone Financial, or if you want to discuss other options for how to reach your financial goals, contact us or visit your nearest branch. 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 it works and help you determine if it’s the right choice for you. 

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