Guide to Refinancing with a Fixed Home Equity Loan

What Is a Home Equity Loan?

A home equity loan is a second mortgage that taps some of the equity that you have built up in your property. You increase the equity in your home over time as you pay your mortgage and the home appreciates in value. In the last year, there has been a 7% average increase in home values across the country. More people have built up substantial equity in their homes than any time in the past 10 years.

With a home equity loan, you can pull out a lump sum of equity and pay a fixed interest rate over a fixed period of time, such as 10 or 20 years. You will know exactly what your payment will be and for how long. While a home equity loan has a higher rate than a first mortgage, it is much lower than most consumer loan interest rates. The loan is secured by your home, which means you can lose it if you do not pay. While this does put your home at risk, it allows you to pay a much lower rate than say, a credit card.

Advantages of a Home Equity Loan

You may pay an interest rate on a home equity loan of 7% or so in 2018, while you may pay 20% or more on credit cards. Also, you will know exactly what you will be paying for the entire life of the loan. The rate will not change, and the term will not change.

If you use your home equity to improve the home, the interest is tax deductible. This can reduce your tax bill substantially.

Disadvantages of a Home Equity Loan

Your house is collateral for the loan. If you do not pay, you will lose your home. During the financial downturn, many people used their homes as ATMs and could not afford the payments when they lost work.

Another problem with home equity loans in the downturn was home values plunged. Many people owed more on their homes than they were worth. This made selling the home very difficult for most because they had to write a check to the bank to sell. If property values drop, you could be stuck in a home for years and not be able to sell without a huge loss.

Getting a home equity loan can be a life saver in terms of saving you on interest. But it will not address the spending habits that may have caused you to get into that debt. If you do not deal with that, you may end up with both credit card debt again and a home equity loan with your house on the line.

Also, if you need to file bankruptcy, it is easier to discharge credit card debt than a second mortgage.

Other Options

If you are thinking about a home equity loan to consolidate debt, here are some things to think about:

Will the plan let me pay off my debt in five years?
Is my total consumer debt less than half of my gross income?

Five years is the maximum time that you can make payments in a Chapter 13 bankruptcy or a debt management plan. That is when the debt is fully retired. If you answer no on both of those questions, you probably have too much debt. You may want to consider other options that do not put your home at risk, such as a zero-interest balance transfer credit card.

If you still do want to pull out equity, you also can consider a home equity line of credit or HELOC. A HELOC is a line of credit based upon your home's equity. You can pull out money as you need it up to your maximum credit line.

A HELOC has a lower interest rate that can vary over time and is lower than a home equity loan. These loans also usually have low closing costs. However, you still are putting your home at risk, and the payment can vary if interest rates rise in future years. HELOCs got many homeowners in trouble during the financial downturn because they could not afford the higher payments when interest rates rose.

Using a home equity loan or HELOC can be a good financial move if you have a solid plan to get and stay out of debt. A home equity loan may be best for someone who is risk averse and wants a defined, set payment plan. A HELOC may be a better fit for someone who wants a lower rate now and will be able to handle a potentially higher rate down the road.