5 Myths About Home Equity Loans
As a homeowner, you have the opportunity to use your property to build wealth or reach other financial goals. One option is taking out a loan against some of your home equity, which is the difference between your home’s fair market value and any remaining mortgage balance. But before you consider this type of financing, understand five common misconceptions about home equity loans.
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Myth #1: There Are Restrictions on Using the Funds
While the loan’s name suggests using the money for home-related purposes, lenders usually don’t put restrictions on use. Popular uses include starting a business, paying off other debts, making home repairs, covering educational expenses, handling an emergency and even purchasing another property. Just beware that the flexibility could also lead to poor financial decisions, such as making lavish purchases.
Myth #2: You Must Wait Years To Have Sufficient Equity
Lenders usually need you to have at least 20% equity before they consider you for a home equity loan. Although you may think this would take years to achieve, you could get there quickly through a large down payment, home appreciation or accelerated mortgage payoff. Consider checking your home’s value and your mortgage balance to see where you stand.
Myth #3: You Can Borrow Against Your Home’s Entire Equity
If you have $100,000 in home equity, you might think you can borrow that whole amount, but the limit is often around 85% to 90%. Home equity lenders look at the property and your overall financial picture to decide what to offer you. For example, your debt-to-income ratio will need to show that you can afford both your current mortgage and the home equity loan alongside other debts. Your credit score will play a role and affect your interest rate, too.
Myth #4: Home Equity Loan Interest Isn’t Tax Deductible
Before the Tax Cuts and Jobs Act of 2017, the deductibility of home equity loan interest wasn’t tied to any specific purpose for the funds. While the tax deduction hasn’t disappeared, the rules are stricter for loans taken out in 2018 through 2025. “Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the IRS.
Myth #5: Home Equity Loans Work Similarly to Personal Loans
While personal and home equity loans both involve borrowing a lump sum typically paid off in monthly, fixed installments, there are many differences. Not only can a home equity loan have a longer term of up to 30 years, but it’s also a secured debt that puts your home at risk if you can’t make the payments. Plus, you can expect a more thorough application process than if you take out a personal loan, though a perk is a potentially lower interest rate.
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