Home equity loans can be perfect in today’s market
A home equity loan can offer great benefits. As a second mortgage, it lets you cash out equity without replacing your existing low mortgage rate. And there are no restrictions on how you can use the funds. So you can take cash for any purpose, from paying off debt to remodeling your home or buying a vacation property.
With mortgage rates on the rise, few homeowners are tempted to refinance. But a home equity loan could be the ideal way to access the cash you need.
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Overview: Home equity loan pros and cons
The biggest benefit of a home equity loan is that you can cash out your home’s value without refinancing. That makes it a great option when mortgage rates are high.
|Tap equity without refinancing||One-time payout|
|Fixed interest rates and payments||Repayment starts right away|
|Lower rates than HELOCs||Higher rates than refinancing|
|Use the funds for anything||Second mortgage payment|
Benefits of a home equity loan
A home equity loan is a great way to access your property’s cash value.
Compared to cash-out refinancing, home equity loans should have lower upfront costs — and they don’t reset your current mortgage, which is good news if you already have a low rate. Compared to HELOCs, home equity loans are generally safer because your rate and payment can never increase.
Let’s dig a little deeper into those benefits.
1. Tap equity without refinancing
For years, a cash-out refinance was the go-to way to tap your equity. Cash-out refinancing involves closing your old mortgage and replacing it with a new one that offers cash back at closing.
As long as mortgage rates are falling, a cash-out refinance can lower your mortgage rate and monthly payments — even after taking out the cash you need. That’s a pretty great deal. But when interest rates rise, replacing your old mortgage is a lot less appealing.
In a high-rate enviroment, most homeowners prefer a home equity loan or a home equity line of credit (HELOC). These “second mortgages" let you tap equity without replacing your existing mortgage — so you pay the higher rate only on what you cash out. And since you’re borrowing a smaller amount, closing costs should be lower, too.
2. Fixed interest rates and payments
Unlike HELOCs, home equity loans come with fixed interest rates. That means your monthly payments will be the same over the life of the loan, and you never need to worry about a surprise rate or payment increase.
This can offer borrowers extra peace of mind. And the predictability of a home equity loan makes budgeting much easier and the loan much safer. For many, this is a key benefit of home equity loans when compared to HELOCs.
3. Lower rates than HELOCs
Traditionally, home equity loans have lower rates than HELOCs. A HELOC might offer a better “teaser” rate at the outset, but since HELOC rates are variable, your costs could go up over time. By contrast, a home equity loan can offer a lower rate for the full loan term.
As with any type of loan, the interest rate you pay on a home equity loan or HELOC will be determined by your personal finances. Your credit score plays a crucial role. And so do your debt-to-income ratio (DTI) and loan amount.
If it’s a toss-up, get quotes from several lenders for each loan type so you can find your best rate and overall deal. Just remember, HELOC rates may increase later on, whereas home equity loan rates are usually fixed. Check your loan offer for details.
4. You can use the funds for anything
One of the most attractive home equity loan benefits is that you can use the money for anything you want.
Of course, it’s smart to use the funds in ways that improve your life — like for home improvements or emergency funds that could see you through hard times. A home equity loan can also be a great way to consolidate higher-interest debts and save money from month to month.
It’s usually not wise to spend your equity on “luxuries” like expensive vacations or new cars. These won’t bring you any long-term returns, yet you could be paying off the debt for decades to come. That said, it’s your money to use how you like.
As an added benefit, if you do spend some of the money on home improvements, you may be able to deduct the loan interest on your federal tax returns. This site does not give tax advice, so read the relevant IRS webpage and/or consult your tax adviser to learn more.
Downsides of a home equity loan
No matter how powerful home equity loan benefits are, nothing’s perfect. So let’s take a look at some downsides.
1. One-time payout structure
Among the best home equity loan benefits are certainty and predictability. You’re getting a straightforward, fixed-rate installment loan with a single lump sum at closing. That makes a home equity loan less risky than a HELOC, which could have drastically different payments over time depending on the interest rate market.
But a HELOC is more flexible. It lets you borrow, repay, and borrow again as often as you like during the initial draw period. This structure can be ideal for those in the gig economy or whose work is seasonal because it allows them to withdraw cash as needed during times of lower income and repay when they’re earning more.
Plus, with a HELOC, you make interest-only payments during the draw period. This can also be helpful if you want to borrow a large sum for a short time. Just watch out for early payment penalties, annual fees, and other fees.
All in all, a HELOC offers a lot more financial flexibility than a home equity loan. But the tradeoff is that you have to accept the additional risks that come with HELOC repayment.
2. Repayment starts right away
With a HELOC, you pay only interest during the draw period. With a home equity loan, you start making regular loan payments right away. So you’ll have a bigger payment from the outset.
Of course, you might see that as a benefit of a home equity loan, because you start paying off your loan balance right away. With a HELOC, unless you choose to pay the balance early, you’ll see your payments shoot up later on.
But it does make a home equity loan’s monthly payments more costly to start with. So if cash flow is an issue right now, you might prefer a HELOC.
3. Higher rates than cash-out refinancing
Home equity loans pretty much always have higher interest rates than cash-out refinances. When mortgage rates are low, you could actually get cash back and save money on your entire home loan using a cash-out refi. But that’s not the end of the story.
If refinance rates are above your current mortgage rate, you might still be better off with a home equity loan. That’s because you’ll be refinancing your entire mortgage to a higher rate. And that could cost you dearly.
With a home equity loan, the higher rate applies only to your immediate borrowing. And that’s likely to be a much smaller sum.
Similarly, you pay closing costs on your whole new mortgage with a cash-out refinance but only on your cash-back with a home equity loan. So upfront loan costs are likely to be lower, too.
4. Creates a second mortgage payment
A cash-out refinance has the advantage of rolling your mortgage and your cash-back into one loan. So you end up with a single monthly mortgage payment. Some homeowners like the simplicity of this structure. By contrast, a home equity loan is entirely separate from your original mortgage — so you’ll end up with two home loans and two monthly payments.
That’s not necessarily a deterrent; it’s often cheaper to get a home equity loan on top of your current mortgage, even though you’ll have two payments. But a second mortgage can make it more difficult to refinance or take on additional debt later on. So it’s something to think about.
Is a home equity loan a good idea right now?
Whether or not a home equity loan is a good idea depends on the current rate environment and your existing mortgage.
When this was written, near the end of 2022, home equity loans were generally a great idea. Mortgage rates soared throughout the year, and that all but wiped out the usual benefits of cash-out refinancing.
Of course, if mortgage rates have fallen again by the time you read this, refinancing could be a more attractive option.
It’s also important to consider your existing mortgage loan. If you’re almost done paying it off, refinancing likely won’t make sense — even if rates are ultra-low. You’d restart your loan and likely end up paying a lot more interest in the long run. In that case, a home equity loan or HELOC probably still makes more sense than a cash-out refi.
Ask your loan officer to walk you through all your options for borrowing equity. The right answer looks a little different for everyone, but a good lender will help you choose the best loan product for your needs.
Should I get a home equity loan or a HELOC?
Some homeowners prefer a home equity loan while others choose a HELOC. There’s no “right” answer. Your decision should be based on how much cash you need, how you’ll use it, and your tolerance for risk.
If you know exactly how much money you want to borrow upfront — for example, borrowing a lump sum for a kitchen remodel or to pay off debt — a home equity loan could be better. You can take a lump sum upfront and start paying the loan off right away.
But a HELOC might be better if you want some flexibility. As a line of credit, a HELOC lets you access cash on an as-needed basis. This could be great if you’re doing an extended renovation project with uncertain costs, or if you simply want to have extra cash available in case of emergencies.
But, as we said above, there’s a tradeoff for the freedom you get with a HELOC. Interest rates are variable, and you could face higher rates and loan payments later on. So you need to have a higher tolerance for financial uncertainty. If you prefer to have a clear budget, a home equity loan could be better.
You can read “HELOC vs. home equity loan: Pros and cons" for more information.
Home equity loan benefits: FAQ
The interest you pay on a home equity loan may be tax-deductible if you use the money to buy, build, or substantially improve your home. But be sure to consult a professional tax adviser about your situation to see if that rule applies.
If you need to borrow a large sum of money, taking equity from your house is often the best way to do it. Interest rates are far lower on home equity loans and HELOCs than on personal loans or credit cards, so you could save a lot. Just remember that your home is on the line, so you need to be sure you can afford the loan and make payments on schedule. You don’t want to risk defaulting on your home equity loan.
Home equity loans are usually better than refinancing when mortgage rates are on the rise. A home equity loan can also be better if your existing mortgage is almost paid off and you don’t want to restart it. Cash-out refinancing is usually the better option when interest rates are low and you can reduce your total mortgage cost while taking cash back.
You can use your home equity for anything you wish. But most prefer to use their money wisely — for instance, by paying for home improvements, buying an investment property, or financing a sure-fire business venture. Equity borrowing can also help boost emergency funds. Another good option is to consolidate your existing, high-interest debt to reduce your monthly payments. But don’t do that unless you have a household budget that will make your lifestyle financially sustainable.
A home equity loan won’t impact your existing mortgage payment. But it will add its own, separate monthly payment. So the total amount you pay each month will increase.
Technically, you could take equity out of your home right after closing on your first mortgage — provided you made a large down payment or bought your home with cash. The only real constraint is that you need enough equity to borrow against while leaving 20% untouched. If you made a small down payment, it could take a few years before you have enough equity to cash out. If you put down more than 20%, you might be able to tap equity right away.