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5 ways to use a home equity loan wisely

Understand the home equity loan and the ways to use it to your benefit.

This article is sponsored by Navy Federal Credit Union. Navy Federal Credit Union is federally insured by NCUA.

Picture this: It has been a while since you upgraded from military housing to your own home and you’re lounging in your living room, sipping coffee and pondering life’s mysteries. Suddenly, your home whispers to you, “Hey, I’ve been working hard to appreciate in value. How about we team up and unlock some of that sweet equity?” That’s right, we’re talking about home equity loans—the financial genie that lets you tap into your property’s potential without needing a magic carpet or a flying lamp. But before you rush off on a magic carpet ride of your own, let’s dive into the mystical realm of home equity loans and see if they’re truly a tale of financial enchantment or just another genie in a bottle.

A home equity loan, also known as a second mortgage, is a type of loan that allows homeowners to borrow money using the equity they have built in their property as collateral. Equity is the difference between the current market value of the home and the outstanding balance of any mortgages or liens on the property.

Home equity loans typically come with fixed interest rates and are provided as a lump sum amount. The borrower receives the funds upfront and then repays the loan in regular monthly installments over a set period, which is often five to 30 years. The interest rates for home equity loans are usually lower than those for unsecured loans such as personal loans or credit cards because the home serves as collateral, reducing the lender’s risk.

There is also a difference between a home equity loan and a home equity line of credit (HELOC). A home equity loan provides a lump sum with a fixed interest rate and fixed payments, while a HELOC offers a revolving line of credit with variable interest rates and more flexibility in borrowing and repaying. The choice between the two depends on your financial goals, borrowing needs, and risk tolerance. It’s important to carefully review the terms, interest rates, fees, and repayment structures of both options before making a decision.

Sometimes home equity loans can get a bad rap. When considering a home equity loan, there are quite a few factors to consider. A home equity loan can be a good idea for several reasons, but it’s important to note that everyone’s financial circumstances vary. What may be beneficial for one person might not be the same for another, especially military members who PCS often and may or may not be holding onto a home long enough to utilize its benefits.

Here are some situations where a home equity loan could be considered a good idea:

  1. Home improvements: The number one reason to get a home equity line of credit would be to invest in home improvements or renovations that can increase the value of your property. Using a home equity loan to finance these upgrades might make sense, as you’re essentially reinvesting in your asset and potentially improving its long-term value.
  2. Lower interest rates: Home equity loans typically offer lower interest rates compared to other forms of borrowing, such as credit cards or personal loans.
    A good example of a low-interest rate is through Navy Federal Credit Union. They offer APRs as low as 6.640% on home equity loans and 8.750% on HELOCS. If you have high-interest debt, using a home equity loan to consolidate that debt could save you money on interest payments. But be cautious when using a home equity loan for consolidating debt—see the next point for why.
  3. Debt consolidation: If you have multiple debts with varying interest rates, combining them into a single home equity loan with a lower interest rate can make it easier to manage your debt and potentially reduce your overall monthly payments. However, this is not a fix-all, it could just be a band-aid. If the debt you were consolidating comes from poor financial health, there is a bigger problem. Make sure you have a plan to pay off your overall debt, which includes healthy spending habits. This would not be a good option if your financial choices continue to lead you further into debt.
  4. Financing major expenses: Home equity loans can be used to cover significant expenses, such as medical bills, education costs, or starting a business. They also might be an option if you have major life events on the horizon, like investing in an engagement ring or setting aside money as you expand your family. If you have a clear plan for how you’ll use the funds and repay the loan, it can be a viable option.
  5. Tax advantages: In some cases and depending on your area’s tax laws, the interest paid on a home equity loan may be tax-deductible. This can provide additional savings, but it’s essential to consult with a tax professional to understand the specific tax implications.
  6. Stable income and repayment capacity: If you have a stable income and can comfortably manage the loan payments without stretching your budget, a home equity loan might be a reasonable option.

However, it’s crucial to exercise caution when considering a home equity loan. With any loan or investment, there are a certain number of risk factors that come into play that you need to understand before signing on the dotted line:

  • Risk of losing your home: A home equity loan uses your property as collateral. If you’re unable to repay the loan, you risk losing your home through foreclosure. So don’t get that loan to buy your worldwide dream vacation.
  • Changing interest rates: If you opt for a variable-rate home equity loan, your interest rate could change over time, potentially leading to higher monthly payments.
  • Accumulating more debt: Taking on additional debt without a clear plan for repayment could lead to financial strain.

Before deciding on a home equity loan, carefully assess your financial situation, consider alternative options, and seek advice from financial experts or advisors to make an informed decision that aligns with your long-term goals, financial well-being, and military service. It is also crucial to go with a lender you trust. Navy Federal not only has competitive interest rates for their loans, but they understand the uncertainty of military life. Additionally, they will walk with you every step of the way.

Not sure what your home equity loan or line of credit could be? Use the helpful Navy Federal Equity Calculator to find out based on your home’s value and how much you owe on your mortgage.

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