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by Christy Bieber | Published on Nov. 29, 2021
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Don't end up with a home equity loan that's not a good fit.
Home equity loans are made available by many different lenders. They all require you to use your home as collateral, which is where they get their name, since you're tapping into the equity in your house. And they're all a type of second mortgage, with your first mortgage remaining unchanged.
One of the big differences between home equity loans is that some of these loans are fixed-rate loans and others are variable. You'll need to decide what type of interest rate structure is right for you. Let's take a look at the pros and cons of each option so you can make an informed choice.
Fixed-rate home equity loans have one major advantage over variable-rate loans: The rate is set in stone and it cannot change during the time you are paying it back. This means that before you commit to borrowing, you'll know exactly what your monthly payment is going to be for the duration of the time you're repaying your debt. You will also know your total costs of borrowing.
With no surprises coming down the pipeline, you can make certain the home equity loan fits in your budget and that you're comfortable with what you're paying to borrow. You'll have peace of mind knowing you didn't gamble your house on rates not going up by so much that the loan becomes unaffordable.
The downside, however, is the starting rate on your home equity loan is going to be higher if you opt for a fixed-rate loan than a variable-rate one. That can make the loan harder to qualify for and can leave you with more expensive payments at the start. You also take the chance of your loan being more expensive over time than with the variable-rate loan, if rates don't rise. Of course, if rates fall, you do have the option to refinance if you want -- but this can come at an additional cost, and you'd need to meet lender requirements to secure a new home loan.
The downsides and upsides of a variable-rate loan are the opposite of those of a fixed-rate loan.
With a variable rate, the big benefit is that your starting interest rate is lower. You save money in your initial payments compared with a fixed-rate loan. And because of the lower payment, it may be easier to get approved.
The downside is, the rate could rise and you may end up paying more than you would have if you'd opted for a fixed-rate loan from the start. No one has a crystal ball that can predict if this will occur. You'll need to review the loan terms carefully to ensure the rate and payment can't go so high that they become unaffordable to you.
Ultimately, you'll need to decide if you'd prefer the certainty of the fixed-rate loan even if it means your starting rate is higher, or if you want to gamble on saving money using a variable-rate loan if rates stay low. Just remember, your house is on the line, so think about the big picture when you make this choice.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
The Ascent's in-house mortgages expert recommends this company to find a low rate - and in fact he used them himself to refi (twice!). Click here to learn more and see your rate. While it doesn't influence our opinions of products, we do receive compensation from partners whose offers appear here. We're on your side, always. See The Ascent's full advertiser disclosure here.
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