A home equity mortgage could be a good option if your goal is to fund a major home improvement project, such as a kitchen renovation, an addition to your home, or a roof replacement. As collateral, use your equity in your home to finance the projects. Consolidate your high-interest credit cards debt, send your kid off to college.

A loan is a good option if you’re looking to make major renovations in your home.

Bathroom remodels, kitchen overhauls, and even fixing a stubborn leak in the basement can cost big bucks. Here are the details of how home equity loans work.

What is Home Equity Loan?

A home equity loans are similar to traditional mortgages. A lender will lend you money in one lump sum.

The borrower pays monthly the same amount to pay off principal and interest.

These monthly installments are predictable and the rate of interest doesn’t change over the term of the loan. This could be anywhere from 5 to 15.

To Calculate your equity. Simply subtract your current assessed amount from any amount you owe for your first mortgage. This is the amount of equity that you may be eligible to borrow against when you take out a loan on your home equity.

A bank might not loan this entire amount. However, many banks lend credit up to 80% of loan-to value (LTV).

For example, let’s say your home is worth $200,000 and your LTV amount equals $160,000. Your county assessor may not be able to give you a complete assessment. Banks might also need their own assessment.

Home Equity Loan or Home Equity Line of Credit

Both are backed by equity in your house and are second loans. However there are key differences.

A home equity loan comes with a fixed monthly repayment because the interest rates, borrowed amounts, and payoff periods are all set.

A home equity line-of credit (HELOC), in contrast, is closer to a traditional credit card. You can borrow against it as often as you need it up to the limit set by your lender.

The interest rates are variable but HELOCs usually have a cap. Most banks offer a promotional rate of interest for the first year. If the rate does not increase, it will be reduced.

Once you have qualified for a HELOC the lender will give you an initial interest rate and a draw term during which you’ll make monthly payment on the interest.

To pay off your loan completely by the date set, you’ll have to start paying back the principal as well as the interest after the draw period. If you sold your home before this date, you would have to pay full amount.

How do I use a loan to my home equity?

HELOCs, as well as home equity loans, have similar applications. They can be used to remodel their homes, consolidate credit card debts or to get a lower interest loan.

The difference is that, with a Home Equity Loan, you get one lump sum after your loan is approved. If you need more money, then you will need another loan.

The HELOC is a variable interest rate. It allows you to draw and pay back the amount whenever and wherever you choose. As long as your limit is not exceeded and the lender is paid back by the due date, the HELOC can be used.

What are the pros and cons of a Home Equity loan?

Pros

Since the majority of aspects of a loan to home equity are fixed, it’s easy remember your monthly installment because it remains the exact same amount each month.

Furthermore, your fixed interest rate will stay the same throughout the loan term. It won’t fluctuate as lending rates change.

If the loan is for a genuine home upgrade, and not personal debt or other items, you can deduct interest each year from your taxes.

Because they are backed with your home’s equity, home equity loan interest rates are typically lower than personal loans. They also have an extended pay-off period.

Cons

The home equity loan is a stable loan, but other types may not be as expensive or provide better long-term results.

You might find that banks offer a low rate of interest for the first one year of a HELOC. If you want to pay off your loan quickly, this could be an option.

Consider refinancing the first mortgage you have and consolidating your estimated renovation costs into the new loan.

You will then pay less interest on the whole amount borrowed, and only one payment would be required.

A home equity mortgage can be a powerful tool to improve your home’s value and consolidate debt. However it is important to evaluate the terms of the loan, as well your past borrowing habits, to determine if the loan is right for them.