They’re not just for home repairs.
A home equity loan simply means that you’re borrowing money using the value that has built up in your home as the loan collateral. It can be a particularly viable source of funds for retirees who have lived in a home for an extended period of time. But such loans are also attractive for owners who have seen house values shoot up during hot real estate markets.
How to Determine Home Equity
Simply put, the difference between current market value, or appraised value, and the dollar amount still owed on your mortgage is your “equity.” In the past, some lenders were willing to loan 100% of your home equity. Today, limitations are more likely to be set at 80%, and no more than 90%.
You can secure a lump sum loan with a repayment term at a specified interest rate over a term of five to 15 years. Interest rates for a home equity loan, also known as a second mortgage, are tied to the prime bank rate, and vary as interest rates climb or fall. Today, they are usually in the neighborhood of 3.25 to 3.5%. You will be responsible for monthly payments, and if you are consistently late or miss payments, the deficiencies will affect your credit rating. In cases of default, the home equity lender has the right to collect on the collateral, meaning that a lender can seek foreclosure or sell a property at auction. If, in fact, you have a first mortgage in place, it can get messy.
Types of Loans You Can Get
If you have a specific purpose for a specific dollar amount, a home equity loan for a set term can be a simple way to get the cash. Whether it’s a new car, a one-time home improvement project, start-up funds for a small business or a cash advance to your son for medical school, you have a path to funding that is paid down monthly in set amounts for the life of the loan. A home equity loan can be used to consolidate other debt, sometimes lowering your interest payments by a substantial amount and allowing you to maintain or improve your credit rating.
A second option, known as a home equity line of credit (HELOC) is the preferred vehicle if you are uncertain about the exact sum you might require, or if you simply want funds available for a series of ongoing home projects, recurring college tuition funding or major medical expenses. Although you might be able to take a round-the-world cruise, that use of funds might not be greeted favorably by your banker. A HELOC functions much like a credit card, but because it is collateral, the interest rates are lower, even though they too vary with the market. There may be a stated term, just as there will be a cap to the amount available for a HELOC; when the term expires, you can no longer be allowed to draw on the account, even if you are under your loan limit, although terms can be renewable.
Home improvement loans, by contrast, generally are for specific remodel projects or major additions. They require plans, estimates and timetables up front in order for approval. In addition, lenders will consider each project as an enhancement to the property and will evaluate it for suitability, appropriateness and quality. Also expect to have to pay for an appraisal, and work with a professional architect and/or contractor, as well as regulatory authorities to assure that all work is completed as specified. Home improvement loans certainly have a place, but they are a different “breed.”
If you have occupied your home and built up equity, a home equity loan is often the easier option and does not require that funds be used for home improvements, even though your lender will probably want some idea of how you plan to spend the money.
How to Secure a Home Equity Loan
Many banks and private lenders offer home equity loans and lines of credit. As with any financial program, specific requirements, application fees, terms and interest rates will vary. If you are interested, it pays to explore the options available. Homeowners with FHA loans are eligible for home equity loans and home equity lines of credit just as owners with private or conventional mortgages. Some interest rates can be as low as 2.4%, and terms and amounts are flexible.
In general, in order to quality for a home equity loan you will need an acceptable credit rating, a verifiable source of income, and data about other current debt. You will also have to supply personal and financial information, including purchase date and price of your home, current mortgage information, and current market value figures.
As with any financial transaction, there are pros and cons to home equity loans and home equity lines of credit. Financial advisers recommend a conservative approach. In many cases, however, these loans can be the path to funding for expenses that might not otherwise be feasible. Additionally, there are potential tax benefits of home equity financing that you should explore with your lender or tax adviser.
