Home equity is your home’s value minus the outstanding amount of any mortgage loan on the home. For example, if the value of your home is $300,000, and you owe $100,000 on the home, your equity is $200,000. Home equity is typically used for debt consolidation, landscaping projects, home improvements, tuition fees, new car purchase, emergency auto repairs and other emergency purposes.
A home equity loan, also referred to as a second mortgage, allows homeowners to borrow money using the equity on their homes as leverage. With home equity loans, homeowners can borrow as much as $100,000 and still subtract all interest when filing their tax returns.
A home equity loan is a very good way to way to pay off credit card debt since home equity loans usually have a lower interest rate than non-secured debts like credit cards. For example, if you have a debt of $15,000 on several credit cards which have an average Annual Percentage Rate (APR) of 18%, you can consolidate these debts with a home equity loan which has an APR of 8%.
Types Of Home Equity Loans
There are two varieties of home equity loans; lines of credit and fixed rate loans. Both types are offered with terms that usually range from five to fifteen years. Another similarity is that both kinds of loans must be paid off in full if the home they are borrowed on is sold.
A fixed home equity loan offers the borrower a single, lump sum payment, which is repaid over a fixed period of time at an agreed interest rate. The interest rate and payment remain constant over the life of the loan. The home equity line of credit (usually referred to as HELOC) is a variable rate loan that works a lot like a credit card. It differs from the traditional home equity loan in that, the borrower is not given the whole sum upfront, but instead uses lines of credit to borrow sums within a certain credit limit. Home equity line of credit rates are variable and are generally based on indexes such as the prime rate. Monthly payments are determined by the current HELOC rates and the amount of money borrowed. Like fixed rate loans, home equity lines of credit have a fixed term. At the end of the term, the remaining loan amount has to be repaid in full. You can use our free HELOC calculator or home equity loan calculator which can help you establish how much credit you can get.
To find the best home equity loan, you need to conduct a home equity loan comparison. Factors to be considered include home equity loan interest rates, the term length, fees and penalties. For those who want fast home equity loans, they can opt for online home equity loans.
Benefits For Borrowers
Home equity loans offer an easy source of money. The home equity loan rate, though higher than that on a first mortgage, is significantly lower than on consumer loans and credit cards. As such, the main reason consumers borrow against the equity on their homes through a fixed rate home equity loan is to repay credit card balances. Home equity loan rates are also tax deductible. Therefore, by the home equity loan with debt, consumers end up with a single payment, tax benefits and a lower interest rate.
Benefits For Mortgage Lenders
Home equity loans offer immense benefits lenders. After earning fees and interest on the borrower’s first mortgage, the lender earns even more fees and interest. In case the borrower defaults, the lender keeps all the money earned on the first mortgage, plus all the money earned from the home equity loan. In addition, the lender can repossess the property, sell it and start the cycle again with the next borrower. From a business perspective, this is a very lucrative arrangement for the lender.
Using Home Equity Loans Correctly
Home equity loans can be useful tools for borrowers who are responsible. If you have a steady and reliable source of income and are sure you can repay the loan, its low interest rates and tax deductibility of interest paid makes it a viable alternative. Fixed rate home equity loans can come in handy in covering the cost of one large purchase, such as an unexpected medical bill and a new roof on your home. The HELOC offers a convenient option for covering short term, recurring expenses, such as the tuition fees for a degree course.
The main pitfall of home equity loans is that at times, they seem to be an easy way out for a borrower who could have fallen into a cycle of spending, borrowing, spending again and sinking deeper into debt. This scenario has been referred to as reloading, which is the tendency to take a loan so as to repay existing debt and free up extra credit, which is used by the borrower to make additional purchases.
Reloading leads to a vicious cycle of debt that frequently convinces borrowers to go for home equity loans offering amounts worth 125% of the equity on the borrower’s house. This kind of loan usually comes with much higher fees because, since the borrower has taken money exceeding the house’s worth, the loan has not been secured by collateral. In addition, the interest paid on the amount of the loan which is above the home’s value is not tax deductible.
If you are considering a loan that is above your home’s worth, you will have to think twice. Were you unable to live comfortably when you owed only 100% of your home’s value? If so, it would be unwise to expect that you’ll do better when you raise your debt by 25%, plus fees and interest. This can be the beginning of bankruptcy.
Another pitfall may occur when homeowners take a home equity loan to pay for home improvements. Whereas remodeling the bathroom or kitchen usually adds value to a home, improvements like a swimming pool could be worth more to the homeowner than the market which determines the resale value. If you are going into debt to make superficial changes to your house, establish whether the improvements add enough value to account for their costs.
Paying college education for a child is another common reason for taking home equity loans. However, if the borrowers are almost at the age of retirement, they need to establish how the loans might affect their ability to achieve their goals. It would be prudent for near-retirement borrowers to think of other options for their children’s education.
Clothing, shelter and food are the basic necessities of life, but you can only leverage on shelter for cash. Despite the accompanying risk, there is always a temptation to use home equity to spend on extravagant luxuries. To avoid the problems of reloading, carry out a careful survey of your financial situation before borrowing against your home. Ensure that you understand the loan’s terms and have the ability to make repayments without interfering with other bills.
Bad credit home equity loan
A situation of bad credit is temporary and can be fixed. If you own a home or other property, bad credit home equity loans can be an excellent tool for fixing bad credit. Unlike taking out a second mortgage or a total refinance of the primary mortgage, you may not have to pay any points on this kind of loan. Points refer to lender fees usually charged on real estate loans. One percent of the loan amount is equal to one point. For example, if the charge is one point for a $100,000 loan, then you will pay $1,000.