5 Things to Consider Before Getting a Home Equity Loan

A home equity loan is a secured loan. When you take out a home equity loan, you borrow against the value of your home and use your house as collateral for the loan.

You may be able to qualify for a loan at a relatively affordable rate (around 6% to 8% is common right now -- much lower than the typical credit card interest rate, which is usually around 17% or higher). And, if you have a lot of equity in your house, you may be able to borrow a substantial sum.

Before you move forward with this financial transaction, though, there are five things you must consider first. Here are the key questions you need to ask yourself.

1. How much equity is in your home?

Your home equity equals the value of your home minus what you owe. So if you have a $400,000 house and you owe $300,000, you have $100,000 in equity.

The more equity you have, the more you can potentially borrow. Most mortgage lenders won't lend you 100% of the value of your house, so if you have less than 10% equity in your home, you may not be able to get a home equity loan at a competitive rate.

2. What will the process of getting the loan involve?

Getting a home equity loan can be more complicated than getting approved for other kinds of loans. You may need to provide more financial information rather than just basic details about your income and a credit check (which is all personal loan lenders usually require). You may also need to have your home appraised, which comes at a cost of several hundred dollars.

If you want to borrow quickly and with the minimum of hassle and upfront expenses, a different financial product could be a better fit rather than a home equity loan.

3. How much are closing costs on your loan?

Some lenders offer home equity loans with no closing costs, but you usually end up paying these costs one way or another. Often, you'll be offered a higher interest rate or will be able to finance closing expenses as part of your loan.

Closing costs can actually total between 2% and 5% of the loan amount, depending on the lender and the situation. That's a lot of money to pay upfront just for the privilege of borrowing.

4. Will your interest be tax deductible?

In some cases, interest paid on a home equity loan is tax deductible. To benefit from the deduction, you'll need to itemize rather than claim the standard deduction. You also must have used the proceeds from the home equity loan to build a home or substantially improve upon your primary residence or a second home.

If you meet the requirements, the tax-deductible interest makes home equity loans an attractive borrowing option since the government picks up some of your costs. If you'd owe interest of $1,000 per year and can deduct this from your taxable income, you could save as much as $220 if you are in the 22% tax bracket.

5. Are you willing to put your home at risk?

Finally, the last big consideration is whether you're willing to risk your home for whatever you're borrowing for. You could be foreclosed on if you don't pay your bills, so you'll want to be 100% sure you'll be able to cover your home equity loan costs before moving forward.

By considering these issues, you can make the best and most informed choice about whether to get a home equity loan or not.