In essence, a home equity loan is a breed of a second mortgage in which you are able to take the value of your home, use it as loan collateral and obtain a lump sum of cash. The equity you have in your home is the difference between the actual market value of the property and existing debts attached to it, including a first mortgage.
A home equity loan is great for covering significant expenses such as college tuition, home repairs or the consolidation of higher-interest debts. When a substantial amount of money is needed, the idea of using some of your accumulated equity is always worth considering. However, it is important to proceed cautiously and with sufficient information at hand.
When you obtain a home equity loan, the lender disburses a lump sum amount. These funds may be utilized to pay for a renovation project, pay bills or get rid of more expensive forms of debt. Once a loan of this type has been disbursed, repayment begins immediately at the agreed fixed rate of interest. This, the payment will be the same each month for the duration of the loan term.
This kind of loan product is helpful when cash is needed in a sizable amount. Some other positive attributes of home equity include:
These loan products tend to carry low rates of interest. Because the security on these loans comes from your home equity, they can be made at lower interest rates than personal loans and credit cards. This produces noticeable savings and can be helpful in boosting cash flow when the proceeds are used to repay high-interest obligations.
Home equity loans also have predictable monthly payment amounts, something that makes budgeting and future planning easy. In addition, the Tax Cuts and Jobs Act of 2017 made it possible for mortgage interest on home equity loans to be deducted if the proceeds were put toward renovations that added real value to the property in question.
The cost of borrowing with a home equity loan can sometimes be a bit high. Lenders regularly charge fees on such products, and that is why it is important to look at the APR (annual percentage rate) on any loan, a figure that encompasses the rate of interest and other related fees. Rolling such fees into the loan itself will result in a higher rate of interest.
There is also the added danger of losing your home in the event of nonpayment. Home equity loans are secured by the property itself, and if payments are not made, the lender has the option of foreclosing. Should property values dip significantly, this could lead to an underwater situation in which you owe a greater dollar amount than the home is worth. This can produce serious damage to your credit standing and overall financial picture.
Prospective borrowers should also remember that a piece of property is not meant to act as an ATM, and as such, these loans should only be used to pay for things that will bring value. Launching a business, paying off expensive debt or improving the property are among them. Do not use these loans to pay for frivolous things or else you will always be living well beyond what you are able to actually afford.
Home equity loans are just one way to utilize the equity in your residence to secure needed cash. The HELOC, or home equity line of credit, is a distinct financial vehicle that allows you to do a similar thing.
HELOCs are more akin to credit cards in that they permit withdrawals on a stated line of credit during the so-called “draw” period. In this span of time, it is possible to get money whenever you desire. These periods tend to run for 10 years. As the principal amount of the HELOC is repaid, that amount becomes free once again and can be withdrawan. While the flexibility of such an arrangement can be attractive, it is possible that high interest rate cahrges will accrue of the HELOC has a variable rate.
Borrowers can opt for either an interest-only payment plan or a plan that combines principal as well as interest. If you choose the second option, the loan will be repaid faster. HELOCs generally have variable rates, and therefore the payment can fluctuate, sometimes greatly, over the term of the loan. Though there are lenders willing to offer HELOCs with a fixed rate, these loans usually have steeper rates of interest.
Once the draw period has passed, the repayment period will begin. This is when the principal and any outstanding interest will be paid. The period for repayment is usually longer than the stated draw period, and it may last between 15 and 20 years in some cases. The new tax regulations may make HELOCs deductible provided the proceeds are used for a significant, value-enhancing home improvement endeavor.
You may be wondering if you are better off opting for a home equity loan or a home equity line of credit. In order to determine which is best, you will need to think about how you plan to use the proceeds. Frequently seen purposes for home equity borrowing include credit card debt consolidation, college tuition payments, business start-up and more.
If an expense is of a sizable, upfront nature, home equity loans are preferred, given that they are paid out in a single lump sum amount. If your expenses are less substantial and will not come all at once, it may be wise to explore the HELOC instead.
Each lender has its own standards for those seeking a home equity product. Therefore, it is advisable to comparison shop to be certain of making a sound decision. Broadly speaking, minimum guidelines require a credit score of at least 620, equity of at least 20 percent, verifiable repayment ability and a specific loan amount requested.
The first step is to check the present condition of your credit rating. If you discover that your score is under 620, qualifying for a home equity product may prove difficult. HELOC approval usually requires an even higher credit score than a home equity loan.
Most lenders want to see a loan-to-value ratio of at about 80 percent, meaning that you have 20 percent home equity. This ratio is a comparison of the loan amount and the property’s value. This is verified with a formal appraisal of the home.
All lenders are sure to verify all documentation submitted in support of your loan application, your employment status, your credit score, the property’s appraised value and more, so do not be surprised when you are asked to provide full details of this type.
Prodigy Lending is a DBA of AmCap Mortgage, Ltd. (NMLS ID# 129122 – www.nmlsconsumeraccess.org/EntityDetails.aspx/COMPANY/129122), an Equal Housing Lender.
Managing RMLO: Jason Turner (NMLS #286357)