Building equity in your home starts the moment you make your down payment. This equity continues to build as you chip away at your mortgage balance, make improvements to your home, and let time pass. This doesn’t only work for your benefit when you choose to sell your home; you can borrow against your home in the form of a home equity loan for some of life’s major money milestones.
Sometimes called a second mortgage, a home equity loan uses your home as collateral in return for a one-time payment. The terms of this loan will depend on a number of factors, including your credit score, the market value of your home, market conditions, and more.
Earlier this month, the Federal Reserve raised its benchmark rate by 0.75% to a target range of 3.75% to 4%. When these rates go up, it’s not uncommon for loan rates to go up as well.
This week’s home equity loan rates
Home equity loan rates remained unchanged this week after a slight uptick last week in response to the Fed’s latest move to curb inflation. Here’s a look at this week’s average interest rates for home equity loans, compared to last week’s rates, as well as the best home equity loan rates in your area.
View this interactive chart on Fortune.com
What is a home equity loan?
A home equity loan allows you to borrow against the market value of your house and receive a lump sum payment in return. For homeowners looking to finance larger projects or costlier expenses, borrowing from their home equity can be an invaluable tool, especially because home equity loans tend to have lower interest rates than other types of loans such as student loans or personal loans.
A few instances when you might consider a home equity loan:
Home improvement projects: Adding a deck to your home or remodeling your bathroom or kitchen can be a major value driver and help you get an even better return on your investment should you decide to sell your home. But these upgrades can also be costly and may not fit neatly into your budget. Using a home equity loan to finance these projects gives you the flexibility to pay for them over time, and you do have the option of using your home as collateral for a home equity loan to cover the cost of those projects.
College costs: Home equity loans typically have lower borrowing rates, making them an attractive option for covering college costs. The downside: You could also miss out on certain loan protections and forgiveness programs available for federal student loan borrowers. Going this route could help you save, but there are still financial risks involved, so tread carefully.
Debt consolidation: High-interest debt can be challenging to pay off if you’re paying more interest each month than toward your principal balance. Using a home equity loan to simplify multiple loan payments and potentially score a lower interest rate could save you tons over the life of your repayment period.
Emergency expenses: It’s important to have an emergency fund to catch you when you fall, but building up a decent cushion takes time. For example, if you find yourself in a situation where you need to cover an unexpected medical expense, a home equity loan could be a relatively low-cost option for doing so. However, it’s important to come up with a plan for how you’ll repay that loan once all is said and done.
How do I calculate my home equity?
To figure out how much equity you have in your home, you’ll need to calculate the difference between the fair market value of your home and how much you still owe. Say your current outstanding mortgage balance is $150,000 and your home’s current market value is $350,000; that means that you have about $200,000 of equity in your home.
Keep in mind your home’s market value will fluctuate over time as you pay down your mortgage balance, your home’s condition changes, or there are shifts in the housing market and property values in your own neighborhood. Keeping a close eye on your mortgage balance and how your neighborhood and the economic climate around you is changing can give you a more accurate read on how your home equity is changing over time.
Pros and cons of home equity loans
While home equity loans give homeowners an extra avenue for financing large purchases, they are not without their own set of risks. A home equity loan still requires that you use your home as collateral. If you don’t have a solid repayment strategy in place or your home’s equity sees a drastic decline, you could still end up paying thousands in interest or owing more than your property is worth.
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Pros: Home equity loans usually have fixed interest rates. Consistent payment amounts can make repayment feel more manageable.
Pros: Interest on home equity loans may be tax-deductible. Who doesn’t love a freebie come tax time? If you use your home equity loan to cover the cost of home improvements and you meet the IRS’s requirements, you can shave a little off the top of your tax bill.
Con: Using your home as collateral is a risky move. Defaulting on a home equity loan could mean losing your home.
Con: If your home’s value declines, you could end up owing more. Negative equity is a real thing. If you borrow a large amount and your home’s value plummets below that amount, you can find yourself owing more than your home is actually worth.
Before taking out a home equity loan, weigh the potential risks and rewards to help you determine if it makes the most sense for your long-term financial plan.
Frequently asked questions
What credit score do you need for a home equity loan?
A FICO score of at least 680 is typically required by most lenders for a home equity loan.
Are home equity loan rates higher than mortgage rates?
Home equity loan rates are slightly higher than mortgage rates, because these loans are only paid back after primary mortgages have been fully repaid. If the home goes into foreclosure, the lender holding the home equity loan does not get paid until the first mortgage lender is paid.
Are home equity loans tax deductible?
The interest you pay on home equity loans may also be tax-deductible for the first $750,000 for single filers ($375,000 if married filing separately). To qualify for this deduction, you must use the funds to “buy, build, or substantially improve your home” and itemize your returns, according to the IRS.
This story was originally featured on Fortune.com
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