Home Equity Loan - Tour by FAQ's
What is home equity?
Home equity is the part of your home that you actually own. You
can calculate your home equity by taking your home’s value and subtracting
your mortgage. If your home is valued at $200,000 and you have a
$50,000 mortgage, your home equity is $150,000.
What is a home equity loan?
A home equity loan is loan that is secured by your home. If you
default on a home equity loan, you could lose your home.
What is a second mortgage?
A second mortgage is another name for a home equity loan. The mortgage
on your home is your first mortgage and a home equity loan is your
second mortgage.
What are the advantages of a home equity loan?
The two major advantages of a home equity loan are a lower interest
rate and tax savings.
The interest rate you pay on your average home equity loan is lower
than the interest rate you will pay on your average credit card
by 7% to 10% or more. Home equity loans also have a lower interest
rate than personal loans and other types of non-secured debt.
For home equity loans, you can generally deduct the interest you
pay on the first $100,000 you borrow. For purposes of home improvement
or to buy another home, you can deduct even more. The interest you
pay on a credit cards and personal loans is generally not tax deductible.
What are the disadvantages of a home equity loan?
Your home is on the line and if you default on payments you could
lose your home. There is a cost to take out a home equity loan –
you will pay money both in interest and fees when you take out a
home equity loan.
What can I use a home equity loan for?
You can use a home equity loan for anything. Common uses include
debt consolidation (paying off high-interest credit card debt),
home improvements, paying for an education and buying luxury items.
You can also use a home equity loan to pay for medical emergencies
or as a business investment to buy another piece of property.
Are there good and bad uses for a home equity loan?
Yes. Good reasons to take out a home equity loan are for debt consolidation,
home improvements or to a pay for an education. Your money grows.
Poor reasons to take out a home equity loan are to buy luxury items
or to fund living expenses. Your home equity is spent on something
that depreciates.
How much can I borrow?
Lenders will let you borrow up to 80% of your home’s value minus
your mortgage. This means that if your home is worth $100,000 and
you have a mortgage of $50,000, you will be allowed to borrow $30,000
($100K * 80% - 50K=30K). The lender is allowing you to borrow up
to a loan-to-value (LTV) ratio of 80%.
Almost all lenders will allow an 80% LTV, some lenders allow an
80% to 90% LTV, and some lenders even go as high as an LTV of 125%.
As you go above an 80% LTV, the cost of the loan will increase because
of greater risk to the lender.
How long will a home equity loan take to close?
You should be able to close a home equity loan two to three weeks
after application.
What will lenders look at if I apply for a home equity loan?
Lenders will look at your credit history, how much you are borrowing
compared to how much equity you have, how much you spend each month
to pay other debts, your employment history and what you plan to
do with the loan. More
on what lenders look for.
What are the types of home equity loans?
There are two types of home equity loans: a standard home equity
loan (also called a term loan, a closed-end loan or a second mortgage
installment loan) and a home equity line of credit.
A standard home equity loan is a like a traditional loan in which
you are loaned a lump sum of money and you pay that money off in
fixed payments at a fixed interest rate over the life of the loan.
More on standard home equity
loans.
A home equity line of credit works like any other line of credit
but this one is secured by your home. You have a maximum amount
you can borrow. The interest rate is variable and you pay interest
on only the amount borrowed. You credit is revolving which means
that as you pay off borrowed money, you can borrow that money once
again. More on home equity
lines of credit.
Is there any other way I can borrow from my home equity?
Yes. Cash-out refinancing is not a home equity loan but it does
let you borrow from your home’s equity. In cash-out refinancing,
you refinance your mortgage for an amount that is greater than your
mortgage. The difference between your new mortgage and your old
one is a home equity loan.
Let’s say your home is worth $200,000 and you have a $50,000 mortgage.
If you refinance your mortgage at today’s low interest rates for
an amount of $70,000, you can pay off your old mortgage of $50,000
and the difference of $20,000 is your home equity loan. You now
have a new mortgage of $70,000. More
on cash-out refinancing.
What are the advantages and disadvantages of the different ways
I can borrow from my home’s equity?
Home equity loans are more stable since they have a fixed interest
rate and payments. The also have less fees and charges than home
equity lines of credit. The amount of money that you will pay in
interest is fixed and this is very advantageous to those who may
lack financial discipline. Home equity loans are suited to borrowing
large sums in which the entire amount is needed up front.
Home equity lines of credit are useful when you need money at intervals
or you do not know how much you will pay. Home equity lines of credit
are also useful when you borrow a small amount and pay it back quickly.
Two use of a home equity line of credit might be to pay a college
tuition or for an open-ended repair job. Home equity lines of credit
can result in an undesirable ‘balloon’ payment if only minimum or
partial payments are made. Home equity lines of credit should not
be used for debt consolidation. Home equity lines of credit generally
have a lower interest rate than fixed-rate home equity loans.
Refinancing has the advantage of a lower interest than a home equity
loan but it has the disadvantage of having higher closing costs.
A home equity loan generally has a shorter term than refinancing
a mortgage. Refinancing usually takes a few weeks longer to close
than a home equity loan. More
on which home equity loan type is right for me.
What is a balloon payment?
A balloon payment is a lump sum payment that is due to clear an
outstanding balance at the end of the life of a home equity loan.
A balloon payment can be created if you take out a home equity line
of credit and you have made minimum or partial payments on the amount
owing. When your home equity line of credit expires, you owe a ‘balloon’
payment to clear the outstanding balance.
A balloon payment is often thousands of dollars and should be avoided.
To make the balloon payment may have to sell your home, take out
another loan or refinance the balloon amount, or come up with a
large sum of money somehow. More
on balloon payments.
What are the costs involved in taking out a home equity loan?
The money paid in interest is normally the biggest cost in a home
equity loan. You will also pay fees which consist of points and
closing costs. Points are one time fees that are paid at closing
– one point is one percent of the loan amount. Closing costs will
include costs for such things as attorney fees, appraisal fees,
credit report fees and mortgage preparation fees. Closing costs
are usually between 2% to 5% of your loan amount. More
on loan costs.
Why would I not want a ‘no closing cost’ option?
A ‘no closing cost’ option can mean that you are not paying closing
costs up front or your interest rate has increased. If you are financing
your closing costs, you will pay more in closing costs since you
are now paying interest on top of your closing costs. Make sure
you understand the exact implications of this option.
How can I compare different loans?
The
APR, or annual percentage rate, is the single most important thing
to compare when shopping for a home equity loan because it takes
into account both interest and fees. The APR, which is expressed
as a yearly rate, factors in the loan interest rate and all fees
paid to obtain the loan. Generally, the lower the APR, the lower
the cost of your loan. When comparing APR’s between
loans, make sure the other terms and conditions of the loans are
the same.
You
cannot compare the APR of a home equity loan to the APR of a home
equity line of credit. This is because the APR of home equity loan
takes into account the interest rate and all fees paid whereas the
APR for a home equity line of credit takes into account only the
interest rate – fees in a home equity line of credit are not factored
into the APR.
Are there loan terms to be aware of?
Yes. A pre-payment penalty, credit insurance, and an interest rate
increase in cases of default can make a loan more expensive.
A pre-payment penalty is a penalty paid to the lender if you pay
off the loan early. Credit insurance, which is always optional,
can pay off the loan if you die. An interest rate increase in cases
of default increase the loan interest rate for the rest of the loan
term if you miss a payment or pay late. If these terms are in your
loan, make sure you understand them. More
on unfavorable loan terms.
Are there things to be aware when shopping for a loan?
Yes. Some dishonest lenders will seek to make maximum profit at
your expense. They may help you get a loan you can’t afford or overcharge
you for your loan. Beware
of these shady dealings.
Are there things I must do when shopping for a loan?
Yes. Negotiate and comparison shop and let your lender know you
are doing so.
Lenders
and brokers may offer different prices for the same home equity
loan terms to different consumers, even if those consumers have
the same loan qualifications. The most likely reason for this difference
in price is that loan officers and brokers are often allowed to
keep some or all of this difference as extra compensation.
When you have received a loan offer, ask the lender for at least
one of the following: 1) lower the interest rate, 2) waive or reduce
one or more of its fees, 3) lower points. Make sure that the lender
is not agreeing to lower one fee while raising another or to lower
the rate while raising points.
Comparison shop to make sure your loan offer is at least a reasonable
one.
What must I do at closing?
Make
sure you read and understand the entire loan document – do not just
glance over the paperwork. Try to read the loan documents before
you meet to sign the papers. If you are not comfortable with the
terms and you can’t have them changed, don’t sign.
You
must know that you also have three days after you sign the loan
papers to change your mind and cancel the loan for any reason. More
on closing the deal.
|
