15 Things to Consider Before Taking Out a Home Equity Loan

Many homeowners tap into the equity in their properties by taking out a home equity loan. There are benefits to this type of borrowing, including that it can be more affordable than many other loans. But there are downsides, too. If you're considering a home equity loan, here are 15 big things to consider before you act.

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Home equity loans are generally one of the more affordable types of debt. They typically have lower interest rates than credit cards and personal loans. That can make them a great option when you really need to borrow.

ALSO READ: Why Home Equity Loans Beat HELOCs in 2022

Although home equity loans have lower rates than most types of debt, they will have higher annual percentage rates (APRs) than your primary mortgage. That's because they are secondary loans, with the primary mortgage holder having the first claim on the property if you don't pay. That doesn't mean home equity loans aren't a good deal -- just don't expect the same rock-bottom rates.

If you're hoping to tap into home equity, you should explore all your options. One way is through home equity loans, which provide a lump sum amount you access up front and begin paying back.

A home equity line of credit (HELOC) is another choice. They are a type of revolving credit, like credit cards, and enable you to borrow up to a certain amount. You can borrow as much as you want over time, pay back the loan, and borrow again.

ALSO READ: Home Equity Loan vs. HELOC

When you get a home equity loan, lenders may offer a choice between a fixed or variable rate. Fixed-rate loans have the same interest rate and payments for the life of the loan. Variable-rate loans can change and become more expensive. Many people are better off sticking to fixed-rate loans so they don't risk their payments rising.

When you get a home equity loan, you typically have up-front fees to pay your mortgage lender. You can sometimes borrow for these fees, but that leaves you paying interest on them. So you should be aware that you may need to come up with cash up front or prepare to pay a little more for your loan over time.

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Getting a home equity loan approved can take weeks and require a lot of financial paperwork. It can be much harder and take more time than getting a credit card or personal loan.

So if you know you want to borrow this way, you should act early, before you need the funds, and start getting your documents in place ASAP.

ALSO READ: Is a Home Equity Loan Right for You?

Your home guarantees the home equity loan, so lenders won't allow you to borrow an unlimited amount. Many lenders limit total loans against your home to between 80% and 90% of what your home is worth. That includes your first mortgage. So if you already owe 90% of your home's current value on your existing mortgage, you may not get approved for a home equity loan.

Your credit score will impact your eligibility for a home equity loan and affect your rate. If you do not have a good credit score, you may want to work on improving it before you apply for a home equity loan.

ALSO READ: What Credit Score Do I Need for a Mortgage?

Lenders will look at your current debt relative to your income when deciding whether you're eligible for a home equity loan. When your debt-to-income ratio (including the new home equity loan) is too high, you may be turned down or have to pay more interest. If that's the case, you should consider paying off some debt before applying.

Lenders want to know what your home is worth when you apply for a home equity loan. That way, they can ensure you don't borrow more than the house is worth under current market conditions. In some cases, lenders will require you to have an appraisal -- which you pay for -- before they give you a loan.

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A home equity loan is a secured loan, and your house acts as collateral. This means you put your house on the line. If you cannot pay your home equity loan back, you could be foreclosed on. You should really think carefully about this risk when deciding whether taking out a home equity loan is worth it.

ALSO READ: Secured vs. Unsecured Loans: What's the Difference?

Taking too much equity out of your home could be a big problem. You could end up owing more than your home is worth. In that situation, selling your home or refinancing your loans would be more difficult. You'd have to come up with the extra cash you owe your lender.

You should be aware of this risk, especially if you'll be borrowing close to your home's current worth. Property values could fall at any time, and it's nice to have a lot of equity in the house, if possible, so you don't have to worry about ending up underwater.

Taking out a home equity loan will not affect your primary mortgage. Your mortgage lender does not have to agree. And your rate will not change.

If you want to tap into equity and change your current mortgage terms, you should consider a cash-out refinance loan instead. This type of loan involves refinancing your existing loan and borrowing more than you currently owe when you do it.

ALSO READ: 10 Mortgage Rules You Should Know by Heart

Home equity loan rates and terms vary from lender to lender. You should get multiple quotes before borrowing. Contacting multiple vendors can ensure you get the most affordable loan and don't pay more than necessary.

Finally, you should know your new home equity loan will have a separate monthly payment, distinct from your current mortgage. You'll need to remember to make both payments. Your home equity loan also may have a different payoff time from your current mortgage.

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Armed with this information, you can make an informed choice about whether to take out a home equity loan. You may decide borrowing at this low rate is worth it. But you also could conclude that putting your home in jeopardy isn't.

Ultimately, the right choice about whether to take out a home equity loan will vary depending on the details of your financial situation and your future goals.

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