If you’re undertaking a big project like home renovation, which requires a large amount of money, taking out a home equity loan might be a good idea. However, you have to keep in mind that, like any other loan, home equity loans can do more harm than good. This type of loan can be tricky if you don’t do research. Before taking the plunge, be sure to understand the facts.
What exactly is a home equity loan? How does it work?
A home equity loan, or also referred to as HEL, is a type of loan that allows a borrower to use their home’s equity as collateral. The lender will appraise the value of your home in determining the amount of money you can borrow. This loan comes in two payment terms: fixed and adjustable rates.
Equity loans also come with a specific amount of time for debt repayment. In most cases, the amount of time ranges from 5 to 30 years. When repaying the debt, you have to pay the closing cost, which is less than the amount you typically spend on a full mortgage. A fixed-rate equity loan offers a regular interest rate. It is a good option for borrowers who want a predictable interest rate from the start.
Who can apply for home equity loans?
Equity loans are ideal for those who need cash to finance a major project. If you only need small amounts of money, home equity loans are not the best option for you. Home equity loans range from $25,000 to $150,000 depending on the bank. The home equity line of credit or HELOC sets a limit, so you have the option to draw on your credit line anytime you want.
A HELOC can be compared to a credit card. There’s no need to borrow the loan’s full amount. Once you pay your debt back, the available credit will be replenished. If you want to re-borrow the total amount, you have to pay back the loan in full.
The repayment period for HELOC loans is between 10 and 20 years. Repaying the loan can only be done once the draw period closes. HELOC loans have annual fees, and you can also adjust their repayment period. In most cases, the repayment period is tied to the prime rate. HELOC loans can become fixed-rate loans depending on the circumstances and qualifying factors.
HELOC is suitable for borrowers who need varying amounts of money to start a business or any minor projects. It is an excellent option for those who don’t need as much as home equity loans require.
Benefits of Home Equity Loans
Taking out home equity loans with the right information can give you several benefits. Aside from the availability of large sums of cash for your needs, the loan’s interest is often tax-deductible. However, you still need to check the limitations and ask a tax adviser for your eligibility. Another advantage of taking out HEL and HELOC is that they have lower interest rates as compared to credit cards and other types of unsecured loans.
How is your equity determined?
To qualify for a home equity loan, you must know how to determine your equity. So for instance, your home’s value is at $350,000, and you own $300,000 on the mortgage, your equity is $50,000, which is equivalent to 20%. Equity follows a loan to value ratio, which includes your loan’s outstanding balance compared to your property’s value, which is 80%.
You can qualify for a home equity loan if you have an 80% loan-to-value ratio. This means you should own more than 20% of your home before you can take out an equity loan. A $250,000 needs at least 30% home equity so you can be eligible for a $25,000 equity loan.
A few points to remember before applying for a home equity loan:
- Review your current credit score
- Determine the equity you can qualify for
- Know your debt-to-ratio income
- Explore options with banks and lending institutions
- Obtain the necessary information
If loans can help you cover the upcoming expenses, you also need to be prepared, especially in repaying your debt. You will also have to make an informed decision when exploring different types of loans.
Need help shopping for the best mortgage and refinance loans? Contact us and sit down with a local, knowledgable person to discuss your needs.