What is a Home Equity Loan?
You can achieve your financial goals by getting a home equity loan. This is because you can turn your house’s equity in cash. A home equity loan can be applied for at a bank or online lender.
Equity is the difference between your house’s value and the amount you owe to your lender for your mortgage. Equity can grow in many ways. It can increase when an area’s property value increases and when the borrower continues to pay their mortgage on time.
Your home equity and other financial factors will affect the amount of money you can borrow. The lender will inform you about the loan amount, interest rate and monthly payments once you are approved for a home equity loan. The lender will release the funds in a lump sum once you have agreed to the terms.
Common uses for a home equity loan
You decide how you want to spend the home equity loan money. MoneyGeek recommends that you only use the money for essential matters. Examples are listed in the table below.
- Home Improvement: This classic use of a loan to home equity is a great one. In theory, the pain of taking on new debt should be offset by an increase in the value of your home.
- Repaying Credit Card Debt: You can reduce your expenses by using the proceeds from a home equity loan.
- College Expenses – This is not an easy use. You should not sacrifice your retirement security to pay for the tuition of your children.
- Investments The proceeds could be used to purchase an investment property or start a new business. There is a risk that the investment will fail. How can you repay the loan?
- Consolidation of Debt: You might be able save money by taking out a home equity loan.
Calculating your Equity
How can you determine how much equity you own? Although it’s not an exact science, you should be able find an answer close enough. First, find out how much mortgage debt you have. This figure should be updated each month if you receive monthly statements by your lender or servicer. Contact your loan servicer to inquire about your current balance. The next step is the more difficult: you need to determine how much your home actually worth. While a complete appraisal can cost several hundred dollars, there is an easier way to get an estimate. Redfin.com and Zillow.com offer automated valuation models.
Redfin estimates that homes that are not yet on the market usually land within 6 percent or less of their actual value. Your local property appraiser is another reliable source of information. This public official estimates the value of your home to collect property taxes. Keep in mind that property appraisers often aim for a market price that is lower than the full value. They are updated only once per year so that they can capture seasonal swings. You might want to talk with your Realtor or loan officer if you are still unsure about the value of your home.
The pros and cons of a home equity loan
Borrowers who have a plan for how they will use the money and know how to maximize it are best suited for home equity loans. Home equity loans are best used for major expenses such as home renovations or education funding.
Home equity loans generally have many benefits. It is not recommended for everyone.
Overborrowing can lead to debt and financial ruin. To help you decide if a home equity loan is worth your time, it is wise to weigh the pros and cons.
Home Equity Loans: Interest Rates and Fees
Your home equity loan will cost you more than your primary mortgage. Home equity loans are generally more affordable than personal loans or cash-out refinances.
Your home equity loan rate will be affected by factors such as credit score, credit limits, and loan-to value (LTV), ratios, and credit score. Although the prime rate is the most common benchmark for lenders it is possible to use an alternative index like the London Interbank Offered Rat. Rates are also affected by loan terms. The longer the loan term, generally speaking, the higher the rate. A high loan-to value ratio can lead to higher rates because the lender is more at risk.
Apart from the interest on your home equity loan, you will need to pay for title work, credit checks, appraisals and credit checks. Some lenders will cover closing costs while others won’t. If borrowers don’t meet certain conditions, some lenders may require them to repay closing cost.
How to apply for a home equity loan
Most people can get home equity loans. You will need to have excellent credit and substantial equity in order to get a home equity loan. Lenders typically require a FICO score between 720 and 740 to consider your application. Lenders will consider borrowers with credit scores of 620 and higher, provided they can prove a two-year income history.
A home equity loan can be applied for in many ways like a mortgage. You will need to provide proof of income, credit checks, proof of income, proof that you are earning, the estimated value of your property, your mortgage lender’s amount owed, pay stubs, tax returns, and bank statements. You might also need to pay for a title check and an appraisal, depending on the policies of your lender. The bank will need your Social Security number to determine your credit score. You will need to provide documentation of any income you earn from investments or self-employment.
HELOCs vs. Home Equity Loans
A Home Equity Line Of Credit (or HELOC) is another way to convert your home equity to cash. The cardholder receives a revolving credit line and it functions similarly to a credit card. Borrowers receive a fixed amount of money that they can withdraw as needed.
HELOCs allow borrowers to make draws during the draw period set by the lender. This is typically between 5 and 10 years. The repayment period begins after this time. Borrowers can’t withdraw any money.
HELOCs are subject to variable interest rates. Rates will fluctuate depending on market conditions.
The best way to borrow cash is through home equity loans
Although a home equity loan may seem like a simple way to increase your property’s worth, it is not. However, Ed Conarchy, Cherry Creek Mortgage, Gurnee (Illinois), says that refinancing your entire mortgage would be a better choice.
Conarchy advises that you simply redo your first mortgage. You’ll get a lower interest rate and the cash.
The home equity rate is typically one point higher than that of the Wall Street Journal prime rate, which was 3.5 percent for most of 2016. So the 4.5 percent you would pay on a loan to your home is about one point more than the average 30-year mortgage rate. Home equity rates can rise, and they are also variable.
A home equity credit line is a reliable source of rainy-day funds.
You can cancel your home equity credit lines at any time. Home equity loans are not like a mortgage that is only available for as long as you make the payments. Instead, they transfer power to the lender.
Conarchy explains that a home equity line is essentially a personal loan secured against your house. It has all the options where the banker could freeze the loan or call it. This was something we saw all the time back in 2008. We tell people that a home equity credit cannot be used as a rainy-day fund. It might not be available when you need it.
- The lender may terminate the loan if you lose your job or your home values fall.
- You can save money on your mortgage insurance by taking out home equity loans.
Mortgage insurance is required if you borrow more than 80 per cent of the value of your home. This was a common way for borrowers to avoid this fact: they would take out a second “piggyback loan”. However, mortgage insurance premiums have plummeted in recent years, threatening this tactic.
Conarchy states that piggyback loans are no longer a good idea. “Mortgage insurance is now cheaper than ever.”