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How Long Are Home Equity Loan Terms?

Home equity loan terms can range from five to 30 years, depending on your lender. A home equity loan is a lump sum of cash paid to you and secured by your home.

Homeowners across the United States have collectively gained more than $6 trillion in home equity over the last decade, according to data from CoreLogic. Turning that equity into spendable cash sounds attractive if you need to replace an aging roof, cover medical bills or expand a business.

How does a home equity loan work?

A home equity loan is a type of second mortgage that allows you to borrow against your home equity, or the difference between your home’s value and the outstanding loan balance owed on your home. Similar to a mortgage used to buy a home, the loan is repaid in fixed monthly installments and the home is used as collateral. Home equity loans are repaid after first mortgages in the event of a foreclosure.

You typically need a maximum 85% loan-to-value (LTV) ratio to qualify for a home equity loan. Your LTV ratio is the percentage of your home value that is financed by a mortgage. Additionally, you may be limited to borrowing 85% of your available equity, though some lenders offer high-LTV home equity loans.

What home equity loan terms can I get?

Home equity loan terms can be tailored to suit your individual needs. Repayment terms usually start at five years, but can be stretched to between 10 and 30 years, depending on your home equity lender.

Just as some homeowners get a longer-term mortgage to pay off early, you may opt for a lengthier home equity loan payment schedule to get rid of it sooner.

Which home equity loan term should you choose?

The best home equity loan term for you more than likely depends on the monthly home equity loan payment amount you can comfortably afford. After all, your lender will consider your debt-to-income (DTI) ratio, or the percentage of your gross monthly income used for monthly debt payments, when qualifying you for a loan. In most cases, your DTI ratio shouldn’t exceed 43%.

Let’s compare the interest rates and monthly payments on a five-, 10- and 15-year home equity loan, using an online home equity loan payment calculator. The loan balance is $25,000.

5-year home equity loan 10-year home equity loan  15-year home equity loan 
Loan amount  $25,000 $25,000 $25,000
Interest rate*  5.30% 5.60% 5.85%
Monthly payment  $475 $273 $209
Total interest paid $3,513 $7,707 $12,610

*Rates are current as of this writing.

If a nearly $500 monthly payment on a five-year home equity loan for $25,000 would stretch your budget too thin, you might consider a 10- or 15-year term. For an even larger loan balance, it may make sense to opt for a longer home equity loan term to better manage your payments.

Should you consider a cash-out refi or HELOC instead?

A home equity loan may not be the right option for every homeowner looking to tap the equity in their home. Alternatives include a cash-out refinance and home equity line of credit (HELOC).

Cash-out refinancing

With a cash-out refinance, you take out a new mortgage for more than you owe on your original home loan. The new loan pays off your existing mortgage, and you receive the difference between the two loan amounts in a lump sum.

As with a home equity loan, you can use the lump sum for virtually any purpose. One advantage cash-out refis have over home equity loans is that it eliminates the need for a second mortgage payment, because you’re tapping your home equity and refinancing your mortgage with the same loan.

One drawback is that you’ll pay refinance closing costs, which can range from 2% to 6% of your new loan amount. You can also expect to pay more in interest over the life of your loan, especially if you extend your repayment term.

HELOCs

A HELOC, on the other hand, is another type of second mortgage that uses your home as collateral. You receive the funds on a revolving credit line instead of a lump sum, and make payments based on what you borrow and the interest charged on that balance. As long as you have access to the credit line, it can be used, repaid and used again.

HELOCs tend to have variable interest rates, but they can be lower than rates on home equity loans. That’s because home equity loans have fixed interest rates for the entire repayment term and won’t change with market movements.

You may be able to claim the mortgage interest deduction for any of the three home equity programs discussed — provided you use your equity to make home improvements to the home securing the loan or line of credit.

No matter your choice, make a list of the pros and cons of borrowing. Finally, make sure your budget can handle the repayment plan before tapping your equity.

 

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