Questions to Ask When Considering an Equity Loan
Taking out any kind of loan requires careful consideration, but never more so than with an equity loan that’s secured by the value of your home. Still, the low interest rates on equity loans make them appealing, and, like a mortgage, the interest may be tax deductible¹. Combined, that can make for a very low cost of borrowing.
But before you make any decision, first consider these questions to decide whether an equity loan is the right choice.
Do I Have Enough Equity?
In addition to good credit, there’s another requirement to get a home equity loan: equity. If you’re a new homeowner without much equity, an equity loan may not be an option at all. Even if you do have enough equity to qualify, lower equity often means higher interest rates. Different financial institutions will have different requirements, so check with yours to see if you qualify for an equity loan.
Do I Want a Loan or Line of Credit?
There are two primary ways to borrow against your equity: as a standard loan or as a line of credit. Loans give you a lump sum up front with a standard, predictable interest rate over the life of the loan. Lines of credit—typically called HELOCs—allow you to take out money as needed, up to a certain amount. There’s a set time during which you can borrow and you only have to repay (and pay interest on) the amount you use. It’s a good way to pay ongoing and unpredictable expenses, like remodeling or college costs. However, the pricing is less predictable, as the interest rate on a HELOC can change.
Both are good options for certain situations. If you’re not sure which one is the right choice for you, review our list of pros and cons.
What’s My Interest Rate?
Typically, the Annual Percentage Rate (APR) on a home equity loan is: fixed, based on your credit, based on the length of the loan, based on the amount of equity you have, and based on whether you live in the home or not. However, a HELOC typically adjusts based on the current prime rate, sometimes only adjusting at certain set intervals. Be sure you understand what your interest rate is and how it can change, because it can affect your monthly payments—which, in turn, can make your loan more difficult to repay.
What Will My Monthly Payments Be?
Like the interest rate, you want to be clear on what your monthly payment will be. Some loans offer an interest-only payment option, which is an appealing way to keep your costs low. However, be careful with these loans as they typically end with large balloon payments. While they can help you through a financial crisis, you won’t want to make interest-only payments over the life of the loan. If you have to, you’ll want to talk to your lender up front about your payment or refinance options at the end of the loan.
If you want the flexibility of a HELOC but are concerned about interest rates, consider PenFed’s 5/5 Home Equity Line of Credit. The interest rate only adjusts every five years, which provides more predictability. If you’re looking to pay off your loan entirely within five years, this lets you lock in a good interest rate now.
How Long Is the Loan?
Shorter loans will typically have lower interest rates, but require higher monthly payments. Longer loans help keep your monthly costs low, but you’ll be paying more in interest. The length of the loan is your choice, so decide what fits best into your financial plan.
Can I Afford It?
Once you’ve looked into what your interest rate and monthly payments will be, it’s time to answer the big question: can you afford it? It doesn’t matter how appealing the loan terms are if you cannot make the monthly payments. Be sure you understand your exact costs before you commit to a loan.
If you’re shopping for an equity loan, PenFed offers both home equity loans and HELOCs with competitive, low rates. Get in touch today to find out what your financial options are.
¹Consult your tax advisor to determine if the interest paid could be tax deductible.