What Is A Home Equity Loan?
A home equity known is also sometimes known as a second mortgage. It allows a homeowner to borrow money against the equity in their home. Equity is the difference in the value on your home and the amount of money you owe on your home. For example, if your home is valued at $250,000 and you owe $150,000, the equity you have is $250,000 minus $150,000 or $100,000.
There are two types of home equity loans: a fixed-rate loan and a Home-Equity Line of Credit (HELOC). Both are taken out for a period of 5 to 15 years, and both must be repaid in full if the home is sold. The similarities stop there.
With a fixed-rate loan, you are able to get a single, lump-sum of money. You repay that sum over a set period of time with a set interest rate. Just like with a first fixed-rate home mortgage loan, the payment and interest rate remain the same for the lifetime of the loan.
On the other hand, an HELOC is a variable-rate loan that resembles a credit card more than a mortgage loan. As a homeowner, you get approved for a certain spending limit. As you need money, you can withdraw that money using either a special credit card or check. Your monthly payments are then determined by the amount of money you withdrew and the current interest rate.
Why Would You Want A Home Equity Loan?
There are many reasons why you might consider a home equity loan. The first is that it is money that is easy to get to. Your bank is aware that you have the home and knows its value. Determining your equity is relatively easy.
The second is that interest rates on home equity loans are low. They are not as low as first mortgages but are much lower than credit card and consumer loan interest rates. In fact, many consumers use a fixed-rate home equity loan to pay off their credit card balances in order to save money on interest payments.
Finally, you can take tax deductions on home equity loans of up to $100,000. Interest paid on consumer loans, including credit cards, is not tax deductible.
Using A Home Equity Loan Responsibly
Using a home-equity loan is a great way to cover the cost of a large purchase, especially if it is one that was unexpected. As long as you have a steady income and repay on a monthly basis, a home-equity loan is a good alternative to a credit card or consumer loan.
However, make sure that you aren’t using your equity loan as a way to pay off loans you can’t repay, and then spend more again, leaving you in the same boat. Lenders call this practice reloading, which means you take out new loans to cover old loans, getting yourself deeper into debt.
Also, be sure that if you are using your loan to improve your home, that you are actually adding value to your home. For instance, remodeling a kitchen or bath is always worthwhile. Statistics show that homeowners always recoup any money spent on these improvements. However, adding a swimming pool typically is not as worthwhile.
Essentially, make sure that you are using your home equity loan on things that are needed, rather than luxuries that are not necessary. If you decide to take out a home equity loan, be sure that you can make the payments easily on your budget.
Finding The Right Lender
If you determine that a home equity loan is right for you, the first thing to do is contact the lender that has your original loan. Though you can get a home equity through another lending institution, the bank that has your first loan is typically the best place to start. They know you, know your history, and have a vested interest in getting you the money you need because you are already their customer.
However, check around for good interest rates and fees. If your current lender can’t offer you a good deal, you can go elsewhere. There is nothing that states that first mortgages and home equity loans have to be connected in any way.
Also, be sure to understand the terms of your loan, especially if it is an HELOC. Some HELOC loans require you to withdraw money throughout the year, whether you need the money or not. Also, check for prepayment penalties—fees associated with closing the line of credit before the loan is due. Finding a lender with a loan that meets your needs is essential.
What Does A Lender Need From Me?
When it comes to paperwork for the loan, the lending institution will need far less from you than you had to provide for a first mortgage. Although they will look at your credit score, your creditworthiness isn’t quite as important since your loan is one that has collateral and is less risky to the bank. In other words, your home is backing up your promise to pay the loan. This means that if you do not make your loan payments, the lending institution can take your home from you, sell it, and use the proceeds from the sale to pay themselves.
What will be important to the lender is the value of your house and your current income. Therefore, be prepared to show proof of income and be prepared to pay for a home appraisal is yours is more than 2 years old.
Depending upon the numbers, lenders can lend up to 85% of the equity in a home. So, for the homeowner with $100,000 in equity, a lender will loan up to $85,000.
