Here's What Your Home's Equity Can Be Used For

But are home equity loans or lines of credit a better option?

Both a home equity loan and a HELOC are solid options when you need access to cash. You can typically borrow more with a home equity product than a personal loan since it’s secured by your home. And if you’re weighing a home equity product against your credit card, it’s the lower interest rate that will likely catch your eye. Again, since your home is used as collateral, home equity loans and lines will often have a much lower rate than credit cards. And a lower rate means less money spent on interest charges.

The average rate of a 15-year fixed home equity loan compared to the average credit card rate

Determining which is a better option, though, depends on your individual and long-term needs. There are pros and cons to both, so it’s important to really look at your whole financial picture before deciding.

Because HELOCs allow you to draw money as needed, you can advance a sum for your expense and still have the line available for future emergencies or large expenses. You only have monthly payments if you use your HELOC, and often those payments are interest-only during the draw period. HELOCs require some discipline; it’s important to resist the temptation to use them for miscellaneous expenses. 

A Home Equity Loan might be a more attractive option if you simply need a larger lump sum. With this option, you will receive all of the money upfront, allowing you to cover your expense. Because you receive a lump sum, though, be sure to calculate all aspects of your purchase that you will need to cover before applying for your Home Equity Loan. You may want to set up a savings account to keep that money separate and earmarked solely for your purchase.

DTI measures how much debt you currently have relative to your income. A DTI that is too high suggests you may be spread too financially thin to be able to make the payments on your personal loan. Even if you have a good credit score, a high DTI can cause some lenders to deny your application. Using a monthly budget tool is a great way to manage your finances and keep your debt at a manageable level.

There are a few things you can do to make sure you are as prepared as possible to apply for a home equity loan or line of credit.

1. Build and protect your credit. One of the most critical factors a financial institution will look at before approving you for a Home Equity Loan or a HELOC is your credit score. The better your score, the more likely you are to be approved at a favorable interest rate. Before you apply, you should get your free credit report and score. Check your credit report – from all three bureaus – thoroughly to ensure there are no errors. If your credit isn’t as good as it can be, and you can hold off on making your purchase, you may want to work on improving your score before you apply. Our free guide to Using Credit Wisely offers more tips and guidance for protecting your credit.
2. Determine how much you can afford. If you are planning to make a major purchase, you’ll want to examine your budget to determine what a comfortable monthly payment might be. If your purchase is an emergency one, work with your financial institution to come up with an amount that you can afford.
3. Shop around. A major purchase is just that, a large financial investment. Research companies who sell what you need, and don’t be afraid to ask about discounts. Look for affordable quality; keep in mind that the most expensive option isn’t necessarily the best option. If you’re facing an emergency purchase, work with the vendor or medical office to come up with a manageable payment plan.

Save time by getting your financial paperwork in order before you apply. Your lender will typically ask for proof of income, homeowner’s insurance policy, and tax returns. They will also get a valuation on your property as well as a listing of existing liens on your property (for example, your mortgage).

After you consolidate debt, it will eventually become very hard to resist using your credit cards. And since debt consolidation often improves your score, you may begin to receive tempting card offers. You must recognize that debt consolidation is only effective if it breaks the cycle of debt. To keep your credit healthy, you can charge a few items per month, but no more than you can afford to pay in full each month. This demonstrates responsible credit card usage, helping your score without racking up debt.

Don’t wait until your payments are late to consider debt consolidation. Keep in mind that late payments will impact your credit score and your credit score is a huge component in determining your eligibility for debt consolidation loans.

A Home Equity Loan might be a more attractive option if you have a single, large project you are going to work on, such as an addition to your home. With this option, you will receive all of your funds upfront, allowing you to pay for architects, contractors, furnishings and everything else that goes into a large home improvement project. Before applying for your Home Equity Loan, be sure to calculate all of the expenses that will be associated with your project, and build in extra for unexpected costs.

The maximum amount you can borrow with a home improvement loan depends on the loan-to-value (LTV) guidelines at your financial institution. At MHV, you can borrow up to 80% of your home’s value. LTV simply states the maximum percentage of your home’s value that your financial institution will allow you to borrow and is designed to protect you in the event your home’s value decreases. When you’re calculating how much you need to borrow, you’ll want to shop around to get several quotes from reputable contractors and build a budget that you’ll stick to.

It’s important to adjust your budget to be sure you can afford the cost of your home improvement projects. A budget will allow you to see all of your income versus all of your expenses, and allow you to adjust where you may be spending your money. Keep in mind that you don’t want to decrease your savings to pay for a Home Equity Loan or Line of Credit. Instead, look for opportunities where you can comfortably cut back on your spending, and determine if your estimated monthly payment will be feasible.