Home Equity and HELOC Loans Complete Guide
In this Home Equity Loan Guide we will cover key information in our 7 sections in obtaining a home equity loan in 2020. And we have included some links to articles and calculators that will help you along the way!
You need enough sufficient home equity to both borrow against and leave an adequate cushion afterwards. In practical terms, that means you need to have at least 10-30 percent equity in your home in order to qualify for a home equity loan in order to both cover the amount of the loan and leave 10-30 percent equity remaining.
Shop around. Competition is a good thing for the consumer, and when it comes to home equity loans, there's plenty to choose from. More competition means lower home equity rates and cheaper prices. Research lenders on the Internet and get quotes on rates and closing costs. Ask about their guidelines on what are the requirements for credit score and loan to value (LTV).
To qualify for a home equity line of credit HELOC, you need three things: home equity, credit and income. These all affect each other, so being stronger in one area can offset being weaker in another. For example, a strong credit score may help you qualify despite having limited equity, or vice versa. Each lender is different, so contact out some lenders to see which one you feel comfortable with and can get the job done.
This question is more in reference to HELOC’s. Fixed rate home equity loans will normally be paid in full when the loan matures. Or the balance will be due in full on that date.
Banks and credit unions usually have competitive fixed rate home equity loans. When shopping around be sure to obtain each lender’s closing cost with a loan estimate (LE). One lender’s rates may appear lower than another but you need to factor in the total lender closing costs.
Contact lenders and obtain written HELOC rate quotes. Ask for the total cost of the loan. One lender may appear to have the best rates on any given day, but that could change the next day. Consider a lock in of the lenders rate, if you like the rate a lender is offering. Ask what their policy is on locking in rates at application.
Online quotes or print advertised rate quotes can be out of date if the market changes. Try to obtain quotes the same day from lenders so you are comparing apples to apples comparisons. Be prepared to provide your true financial information to lenders, so each lender can provide a rate and closing costs quote based on your specific situation.
Home equity loans explained
Let’s tackle some common some questions homeowners ask about when it comes to home equity and borrowing options.
- What is a home equity loan?
Basically it is the same as a second mortgage. A home equity lender lien holder will have 2nd position behind the 1st mortgage lender servicer. The 2nd lien holder lender will have to approve to subordinate in writing to the 1st lien holder. Unless you have no mortgage on the property, then a home equity lender would have the 1st lien position with no subordination necessary.
- More on what is home equity loan?
This type of loan is based on your current appraised home value versus what your current mortgage balance is. Most lenders will only loan up to 75-90 percent of your home’s value. For example, if your home value based on the lenders opinion was $400,000, then 80% of that would be $320,000 on potentially what you could borrow (minus of course any 1st mortgage lien). Each lender’s policy will vary on their specific lending guidelines.
- Combined loan to value (CLTV)
Combined loan to value (CLTV) is what lenders use to calculate the amount of equity you can tap into. This means all loan balances combined versus the lenders appraised value. If you owe $$200,000 on your first mortgage and are taking out a $80,000 home equity loan, and the appraised value is $400,000, this translates to a 70 percent CLTV.
- What is a home equity loan and how does it work?
A home equity loan is when you borrow money using the equity in your home as collateral. That is, you use the portion of your home that's paid for to back the loan. Because a home equity loan is secured by the value of your home, you could lose the property to foreclosure, the same as if you fail to make the payments on your regular mortgage.
HELOC home equity line of credit
Here’s how a HELOC works.
- What is a home equity line of credit?
These are called HELOCs. They generally offer the best home equity loan rates, at least initially, because adjustable rates run lower than fixed ones do. However, that can change over time if market rates increase and your HELOC rate rises with them.
- More on what is home equity line of credit?
HELOC’s are divided into a draw period, typically 5-10 years, when you can borrow against your line of credit, and a repayment period when you pay back whatever you've borrowed. They're usually set up as an adjustable-rate, interest-only loan during the draw period, then convert to a fixed-rate home equity loan when the repayment period begins.
- How does a home equity line of credit work?
With many HELOCs, you can repay loan principle without penalty during the draw period, then borrow again as needed, so it can serve as a reserve pool of funds to use and repay as the situation warrants.
- More on how do home equity line of credit work?
HELOCs are structured like credit cards. You have a maximum credit limit, and can borrow against it as needed. This makes the HELOC a nice choice for funding an ongoing expense, such as college tuition, home repairs etc.. The minimum payment on a HELOC generally covers only the interest and, sometimes, a small bit of principal. The interest rate is variable, and the payment amount fluctuates based on how much money you've borrowed and the current interest rate. HELOCs don't typically have closing costs. Add that perk to the low monthly payments, and the HELOC gives you access to a lot of cash, with very low out-of-pocket requirements.
Fixed rate home equity loans
If you prefer a fixed rate and not being subject to rates fluctuating, then this is the program for you.
- What is a fixed rate home equity loan?
If you'd prefer a lump sum of cash up-front, a home equity loan is right for you. Your out-of-pocket expenses will include both closing costs and amortizing monthly payments. Because they're designed to bring your loan balance to zero at the loan's maturity, home equity loan payments are higher than those of a HELOC. Both the interest rate and monthly payment amount on a home equity loan are fixed.
While home equity loans have higher out-of-pocket costs, they're more stable over time because the payments never change. They're most appropriate for large, one-time expenses, like a home remodel.
- More on what is fixed rate home equity loan?
A regular home equity loan with a fixed rate is useful if you need a lump sum of cash for a particular purpose, such as paying off other, high-interest debts or a one-shot home improvement such as replacing your roof. These are set up as fixed-rate home equity loan, so your monthly payments never change and you begin repaying it almost immediately. Loan terms usually run from 5-15 years.
- What is better a home equity line of credit or fixed rate loan?
The reasons you need the money will help dictate which is best for you. Basically, it comes down to you needing a lump sum amount at closing and having a fixed payment and term, or a credit line, so you can access the cash as you need it. If you know how much you need and will be using all the cash at one time, then a fixed home equity program is best. Unless you wish to borrow again as you pay down the balance, then a line of credit may work better.
Purposes for a home equity loan
There are a number of reasons and purposes home owners use home equity loans, HELOC’s and second mortgages for. Here is a list of the most common purposes (in no particular order).
- Purposes homeowners use home equity loans for:
- College tuition expenses for children
- Student loan payoffs
- Home improvements for a remodeling project for the home or repairs
- Debt consolidation: This would give you one affordable monthly payment, versus multiple payments, reducing your monthly expenses.
- Tax deduction potential you may not have on other debts.
- Medical bills
- Emergency expenses in case you need a cushion to help you through a potential difficult financial time.
- Long term investments are sometimes used by consumers when accessing their home equity. This could be for a second home or vacation home purchase. Or stock market investments.
- When purchasing a new home, this might be used as a piggyback type second loan to avoid paying mortgage insurance (PMI). For example, you are putting 10% as a down payment on the purchase of a home and want a second mortgage for another 10% down so you have a total of 20 percent as a down payment. This would help you avoid an additional monthly amount for mortgage insurance.
- Pay off a partner or spouse to gain 100% ownership
Calculate your potential tax savings
Calculate your home equity
- Tips on calculating your home equity
Check recent home sales in your area that have closed. Your realtor can help you with this or you can search online. You do want a ballpark idea of your home value before spending the time and effort on an home equity loan application. Lenders can also do a quick check for you. It will come down however to an official lender valuation of your home to receive a firm home equity dollar amount you can borrow.
Remember it will be as close to apples to apples as possible when home values are calculated. Values will be based on similar “closed” homes to yours whenever possible.
- What’s your current home loan balance?
Check what the current balance is on your first mortgage as a first step. Depending on how good your credit score is, and how much you would like to borrow, will help in determining the amount of home equity you may be able to access. Again, each lender has their guidelines and requirements that can only be determined after learning your specific financial and home profile.
Let’s say your lender home value comes in at $300,000, and your current 1st mortgage balance is $100,000. That calculates to a 33 percent loan to value. If you want to borrow $100,000 on a home equity loan that would increase
- Subordination agreement
Remember, the home equity loan company will need to agree to a subordination agreement. This will give them second lien position to the first lien mortgage servicer. Without this subordination agreement you will not be able to close on a second mortgage. If you own your home free and clear this becomes a moot point.
The same subordination agreement is also required when refinancing a first mortgage, but still keeping the second mortgage. The second mortgage lender will need to agree to accept 2nd lien priority to the 1st.
- Go to this useful calculator to calculate your home equity loan to value (LTV):
Pros vs. cons
Home equity loans offer a number of pros compared to other types of borrowing.
- Home equity loan interest rates tend to be lower than rates on other types of consumer debt. That's because they're secured loans, where the loan is backed by the equity in your home. Unsecured loans like credit cards and personal loans are backed by nothing but the lender's faith that you'll repay your debts – and that's a riskier proposition, and means you pay a higher interest rate as a result.
- There are no restrictions on how you use the money. While certain types of loans require that you justify your plans for the money - think of putting together a business plan for a business loan, for example – a home equity loan can be spent however you wish.
- Interest on home equity loans is generally tax-deductible, similar to your primary mortgage. However, there are tighter limits on how much you can deduct if you use the funds you borrow for any other purpose than to buy, build or improve a home.
- Qualifying for a home equity loan or line of credit can be easier than obtaining other loans if you have flawed credit. Because the main qualification is how much home equity you have to back the loan, lenders are often more forgiving of credit flaws than they would be if you were seeking to borrow a similar amount through an unsecured loan.
- Repayment terms are often longer than for other types of loans. Standard home equity loans typically allow 5-15 years to repay, while HELOCs allow a 5-10 year draw, followed by a repayment period of up to 20 years.
Yes there are a lot of advantages with home equity loans, but there are some potential cons as well. Keep the following things in mind when deciding on a home equity loan or HELOC.
- Because your home equity serves as collateral for the loan, you could lose your home to foreclosure if you fail to keep up your payments and default.
- Because HELOC rates are adjustable during the draw period, your monthly payments could end up being higher than you expected, if rates rise before you reach the repayment phase.
- You might have to take out a larger loan than you need. Lenders have minimum amounts for both HELOCs and standard home equity loans, which vary from lender to lender. While some will approve a home equity loan or line of credit for as little as $5,000-$10,000, minimums of $15,000-$25,000 are more common. The lenders with the higher minimums may also be the ones offering the best home equity loan rates and terms, so there may be a real temptation to borrow more than you need.
- Home equity loans can make it easy to overspend. If you only need to borrow $7,000 for a home improvement project but took out a home equity loan or line of credit for $15,000, there can be a real temptation to start dipping into the extra $8,000 for odds and ends. Before you know it, you've used up the entire credit limit.
- Home equity loan fixed-rates are higher than what you'd pay for a fixed-rate primary mortgage. So you may be better off with a cash-out refinance, particularly if you can also reduce your primary mortgage rate in the process. A cash-out refinance may also be a better option if you need to borrow a large sum of money.
In summary, if used properly a home equity loan or HELOC can be a useful financial tool. But like any powerful tool, it can hurt you if you're not careful. Know what you're getting into and proceed appropriately.
Rates, rates, rates, let’s take a look at some common Q. & A’s when it comes to finding a lender with competitive home equity loan rates. The rate you are able to qualify for will depend on your credit score, income, assets, and a lender’s appraised value of your home.
Remember closing costs are as important as rate quotes. A low rate may look good but are you factoring in the lenders closing cost fees? If fees are high with a certain lender, another lender with lower closing cost, but a slightly higher rate, may be a better deal overall.
Plus, can a rate offer at application be locked in and for how long? Will you be able to close within the lenders lock in period?
- Best home equity loan rates?
Fixed home equity loan rates and HELOC rates can vary from lender to lender. Banks tend to have the most competitive rates, but their processing can take longer than smaller lenders to close on the loan. Ask each lender what their policy is on locking in the rate at application. Rates can change at any time, so if you are not willing to gamble during the processing of the loan, then you may want to consider locking in the rate. Also, what are the term options they offer, 5 years, 10 years or 15 years?
- More on who has the best home equity line of credit rates?
HELOC rates variable rates and not fixed rates. So rates will have adjustment periods you need to be aware of. You need to ask the lender how the rate can adjust in the future and your options on locking in the rate at some point if the market changes.
- What are the rates for home equity line of credit?
Home equity line of credit rates (HELOC) are based on each borrower’s credit worthiness. In today’s world of home financing, it is difficult to quote rates without knowing each person’s financial and credit profile.