A Simple Guide To Understanding Home Equity Loans |
Posted: January 31, 2018 |
Getting a loan can be intimidating, especially if you’re not familiar with the financial industry. Suddenly, you’re confronted with dozens of terms you don’t normally use, like equity and fixed rates and collateral. Your head starts to swim and you may end up making decisions that can hurt you in the long run. You need someone to help you understand the terms, understand the pros and cons of what you’re about to do, and help you make an informed decision. That’s what we’re here for. Think of us as your loan tour guide. In this post, we’re going to break down home equity loans. We’ll give you a simple explanation of each term, then help you understand exactly what a home equity loan means for you. Ready? Let’s dive in. What Exactly Is A Home Equity Loan?
Your home has a particular monetary value. For example, let’s say your home is worth $150,000 and you still owe $90,000 on your mortgage. The difference between what your home is worth and what you owe is called “equity”. So in this case, you have $60,000 in equity. You can leverage the equity in your home to get a loan from the bank. The bank will see the amount of equity you have and can give you a loan up to that amount. Because your loan is secured by your home, it’s easier to qualify for, as opposed to applying for a loan that is totally unsecured. The bank has more assurance that they won’t lose money. If you’ve ever heard someone talk about a “second mortgage”, they’re referencing a home equity loan. Your first mortgage was the one with which you purchased your house. Your second mortgage is the loan you got from the equity on your home. So far so good, right? Not too confusing. Why Would You Want A Home Equity Loan? Home equity loans have some advantages not available in other loans. Because they’re secured by your home, you can usually get a lower interest rate. The bank knows they can recoup at least some of the funds if you default on your loan, so they’re willing to lend out money at a lower cost. There’s also a better chance you’ll qualify for a home equity loan even if you have bad credit. Again, the bank isn’t as concerned about not being able to recoup their funds. Also, you may be able to qualify for tax deductions with a home equity loan. This isn’t guaranteed and is obviously going to depend on the circumstances and state you live in, but it is a possibility. Be sure to research this aspect. Downsides Of A Home Equity Loan
A home equity loan is not all sunshine and roses. There are some downsides. First and foremost, if you fail to pay your loan, the bank can seize your house and sell it. After all, this is the heart of a home equity loan. Your house is the collateral. Granted, this is a worst case scenario, but it certainly needs to be on your radar. This can be a good thing though in the sense that it motivates you to keep with up with payments. Also, it’s not a sure thing that you’ll get approved for your loan. Since the real estate crisis in 2007, lenders have scrutinized home equity loans more carefully. They typically won’t let you borrow more than 80% of your home’s value (the “loan to value ratio”). It’s possible you might not qualify for the amount you hoped. Kirk Haverkamp puts it this way: Generally speaking, lenders are going to want you to have at least an 80% loan-to-value ratio remaining after the home-equity loan. That means you’ll need to own more than 20% of your home before you can even qualify. So if you have a $250,000 home, you’d need at least 30% equity—a loan balance of no more than $175,000—in order to qualify for a $25,000 home-equity loan or line of credit. Additionally, it can be tempting to spend home equity funds on things that aren’t necessary or don’t raise the value of your home. Depending on the type of loan you get, your bank account may suddenly be flush with cash, tempting you to purchase a massive flat screen television or that car you’ve always been wanting. Generally speaking, home equity loans should only be used on things that will improve the value of your home or life. Motley Fool recommends using a home equity for only the following:
Also, because there’s a lot of value on the line (your home!), scammers tend to target those wanting home equity loans. Don’t ever get into a loan that either seems too good to be true or where the lender won’t put something down in writing. Review all documents very carefully and only do business with reputable institutions. How Exactly Does A Home Equity Loan Work?
Generally speaking, there are two types of home equity loans.
Whether you choose a HELOC or lump sum depends on what you want. A HELOC is the most flexible, and you only pay interest on the amount you actually borrow. However, your interest rate may vary, which means that there’s the possibility it will go up. Additionally, the lender can freeze or cancel your line of credit before you’ve used it. If you need all your funds up front, you may want to choose a lump sum so that your interest rate will remain unchanged and your money will always be available. If it’s possible you’ll only need some of the money, a HELOC may be your best choice. What Should You Do Before You Apply For A Home Equity Loan? Before you apply for a loan, there are several steps you should take. Step #1: Make sure you really want a home equity loan. Remember, with a home equity loan, you’re putting your house on the line. This is a big deal. Is a home equity loan better than a simple credit card or standard unsecured loan? Obviously, it’s going to depend on the amount you’re borrowing and what you plan on using it for. Step #2: Gather your appropriate documents. Lenders are going to want to see, at a minimum, proof of income and a house appraisal. They may handle the appraisal themselves or accept an appraisal you’ve had done. Talk to lenders and ask them what they require before you apply. Step #3: Manage your credit score. Before applying for a loan, check your credit score and make sure everything appears to be in order. If you have a really bad score, you may need to spend time improving it before you’re approved for a loan. Step #4: Evaluate different lenders. There are a large number of options when it comes to getting a loan, including credit unions, banks, online lenders, mortgage brokers, and more. Evaluate their interest rates, repayment requirements, approval amounts, and the other facets of your loan. Step #5: Map out your income and expenses. Your loan is going to add a significant expense to your monthly budget. Be sure that you’ve planned appropriately for repayment over the life of the loan. Conclusion
See, that wasn’t so hard, was it? Now you have a relatively clear understanding of what’s involved in a home equity loan. You’re ready to go into the situation with confidence! You can go forward in home improvements, or funishings. Invest your extra cash into high quality office furniture for your home or business office. Will you be required to do a little research before getting your loan? Yes. You’ll need to determine which type of loan is best for you and the best place to get your loan. But that research will pay off in the end. The time you invest in researching now will be literally repaid in dollars saved on payments. This article originally appeared here at https://www.dccu.us/blog/a-simple-guide-to-understanding-home-equity-loans/ and has been republished with permission from https://www.dccu.us
|
||||||||||||||||||||||||||||||||||||||||||
|