With mortgage rates hovering around 7.5% and home prices continuing to climb in most markets, many potential homebuyers are opting to wait on purchasing a home. But while some buyers may have pressed pause, many current homeowners are taking advantage of what today’s housing market offers them: high levels of home equity.
The average homeowner currently has about $200,000 worth of tappable home equity, which can be borrowed against to make home repairs, complete renovations or even pay off high interest debt. And, while there are a few different home equity loan options to choose from, nearly all of them currently offer interest rates that are lower than you’d get with a credit card or personal loan, making them a smart borrowing option.
But when you’re considering a home equity loan, it’s crucial to understand the monthly costs associated with various options. That way, you can determine whether a home equity loan fits into your budget and your financial plan, both now and over the long term.
How much would a $25,000 home equity loan cost per month?
A home equity loan, often referred to as a second mortgage, enables homeowners to borrow against their home’s equity. The interest rates, loan terms and payment structures can vary among different loan options, and these factors can significantly impact monthly costs.
You have a number of different term options when it comes to home equity loans, but two of the more common are 10- and 15-year loan terms. So, to calculate our average monthly costs, we’ll use three different loan options: a 10-year fixed home equity loan, a 15-year fixed home equity loan and a 10-year home equity line of credit (HELOC).
The same formula can be used to calculate the average monthly costs of all three loan options:
Formula: Monthly payment = P * [r(1 + r)^n] / [(1 + r)^n – 1]
P = Principal amount ($25,000)
r = Monthly interest rate (Annual rate / 12 months / 100)
n = Number of monthly payments (Loan term in years * 12)
Example 1: 10-year fixed home equity loan at 8.75%
When you borrow from your home equity using a home equity loan, your rate is fixed, meaning that it remains the same over the life of the loan. The only way the rate changes is if you opt to refinance it to a new loan with a different rate, which is typically done if interest rates decline.
For this example, we’ll calculate the monthly cost for a $25,000 loan using an interest rate of 8.75%, which is the current average rate for a 10-year fixed home equity loan. Using the formula above, the monthly payment for this loan would be $313.32 (assuming there are no extra fees to calculate in).
Example 2: 15-year fixed home equity loan at 8.73%
Now let’s calculate the monthly payments on a 15-year fixed-rate home equity loan at 8.73%, which is the average rate for this loan as of September 27, 2023. Using the same formula, the monthly principal and interest payments for this loan option would be $249.57.
Note that the average monthly payment for this loan doesn’t differ much from the monthly payment on the 10-year home equity loan above. That’s because, with this loan, you’re paying interest over a longer term (an extra five years), which results in only about a $70 difference in the payments per month.
Example 3: 10-year variable-rate HELOC at 9.10%
Unlike a home equity loan, a HELOC — which is a type of home equity loan with a line of credit that works similarly to a credit card — typically carries a variable interest rate. This means the interest rate you’re paying on it can change based on the overall rate environment.
So, when calculating the monthly interest cost for a 10-year variable-rate HELOC at 9.10%, you would need to consider the possibility of a changing interest rate. But in this example, we’ll assume a constant one for simplicity. We’ll also assume that you’ve used the entire $25,000 line of credit. And when factored together, what we get is a payment of $318.04 per month for this HELOC.
The bottom line
When evaluating different home equity loan options, it’s essential to calculate the monthly costs to determine what fits into your budget. After all, the interest rate, loan term and type of loan (fixed or variable) significantly impact your monthly payments. If you opt for a home equity loan with a fixed rate, you’ll get predictable monthly payments, but if you choose a HELOC with a variable rate, your payments could vary from month to month based on whether rates increase or decrease. But no matter what option you choose, just be sure to do the math and consider all of the variables to ensure you’re making the right decision for your finances.