One of homeownership’s biggest draws is the ability to build wealth in the form of equity. Although most people finance their home purchase with a bank mortgage, they can still build equity and access those funds before selling the property.
Home equity loans allow homeowners to borrow money against their home — the amount of its value above the amount of the mortgage owed. Traditional home equity loans are paid as a lump sum that homeowners repay over time.
A home equity line of credit, or HELOC, is another option. HELOCs allow your home to operate almost like a low-interest credit card, with a line of credit available for continual use up to the amount of the loan
Both loan options have many benefits for borrowers. Here are 12 of our favorite reasons to explore a home equity loan.
1. You get quick access to cash
The most obvious benefit for home equity borrowers is the increase of cash on hand or the availability of an open, low-interest credit line.
Having a lot of money tied up in a home is one of the common challenges of homeownership. A home equity loan allows you to access some of that cash without having to go through the hassle and expense of a sale.
2. You pay less interest
Lower interest rates make home equity loans a popular choice for large purchases or expenses. The typical home equity loan interest rate is less than 10%.
Homeowners might be better served using a home equity loan to cover common expenses like higher education or medical bills. Private student loans and credit card interest rates can reach 15% or higher depending on your credit score.
3. You can spend the loan however you want
Borrowers face almost no restrictions on how they use their equity loans. As a homeowner, it’s up to you whether you reinvest the funds into your home through upgrades or renovations or spend it on something else entirely.
4. You might have a lower tax liability
The funds distributed through a home equity loan or HELOC are not taxed as income by the IRS. And the interest on your home equity loan is tax deductible until 2026 if you meet certain qualifications.
You also avoid a potential capital gains tax with a home equity loan versus selling the home for cash because you’re not making a profit from the sale of your home.
Of course, there’s still a chance homeowners may have to pay some kind of tax related to the loan depending on location. Consult a financial adviser for specific tax advice.
5. You won’t need to refinance
Home equity loans and HELOCs offer access to home equity without the need to refinance your mortgage. Refinancing a home gets expensive quickly and usually comes with a change in interest rate.
Homebuyers who locked in the historically low interest rates of 2020 and 2021, for example, won’t lose those mortgage interest rates if they decide to take out a home equity loan.
6. You have a longer loan repayment period
Unlike typical private bank loans, home equity loans have flexible and extended repayment periods that could last decades. Most home equity loan repayment periods run as low as 5 years to as long as 30 years, not unlike a mortgage.
This flexibility means smaller monthly payments and greater potential to pay off the loan early.
7. You can invest the loan in new real estate
The funds from home equity loans make it possible for borrowers to acquire other real estate investments. The loan could be big enough for a down payment on an investment property in a hot real estate market or an apartment building.
Keep in mind that a new real estate transaction will come with additional expenses like real estate agent fees and closing costs. Use your equity wisely and look for agents with affordable commission rates to maximize the return on your investment.
8. You can use the loan to consolidate debt
A home equity loan can be a great tool to help consolidate debt. Credit card interest rates are notoriously high, making it expensive to carry around credit card debt. Home equity loans and HELOCs have much lower interest rates.
Consolidating debt with your home equity means one streamlined payment at a lower interest rate. The longer loan term means lower payments on larger debt amounts over time.
9. Your property value could increase
Reinvesting your home equity loan into your home can increase its value.
Home purchases are expensive, and many buyers spend most of their free cash flow covering fees. A home equity loan gives you the option to tackle that renovation project you’ve been putting off to build more value on your property.
10. You avoid mortgage insurance
Depending on how much you borrow, you won’t have to get more mortgage insurance the same way you might need to if you refinanced.
But you still may have to pay for mortgage insurance if you borrow more than 80% of your home’s value.
11. You keep your savings intact
Taking out a home equity loan or HELOC means you can keep your other liquid assets intact. That emergency fund you have in a high-yield savings account can continue to accrue interest while you invest your home equity however you see fit.
12. Home equity loans help finance a home sale
If you’re trying to move and sell your home, you can still use a home equity loan for bridge financing. It can take time to find a new home in competitive real estate markets, and it can take time if you’re selling your home on your own.
You can use the equity from the home you want to sell to help finance the purchase of a new home to avoid taking out an actual bridge loan with a shorter repayment period.
What You Need to Know Before Taking Out a Home Equity Loan
Home equity loans have benefits, but they are still an important financial decision that carry risks. Weigh all of these impacts a home equity loan could have on your finances.
Most lenders have an equity minimum
Banks require potential home equity loan borrowers to own a certain percentage of their home outright. You can’t borrow against the equity you don’t have, so check with a lender to assess how much equity you’ve built before you borrow.
Your home is collateral
Home equity loans come with a fair amount of risk. When you take out an equity loan, your home is the collateral for the lender. Failure to make on-time payments won’t just impact your credit score, it puts your home at risk of foreclosure.
Think carefully about your expenses and how much you can afford to pay monthly. You don’t want an emergency to cost you your home.
Early repayment might come with penalties
Longer loan terms on home equity loans mean lower monthly payments, but not all lenders are thrilled when you pay the balance ahead of schedule. If you already know you’ll be able to pay the loan balance early, find a lender who won’t charge you extra for doing so.
Fluctuating home values can impact your equity
Lenders determine equity by factoring the amount of your outstanding mortgage against the appreciation of your home’s value. Taking out a home equity loan when housing prices are high means more money for you. If home prices drop too much, however, it might be some time before you’ll have enough equity to borrow against.