Definition of Home equity loan also known as a second mortgage. The home equity loan is the difference between the value of the property and the amount owing in the mortgage. It is the portion of the home that is owned. Banks and other lenders will often use the equity as security in order to borrow money through a home equity loan. If you owe $150,000 on your mortgage loan, and your home is worth $200,000, you have $50,000 of equity in your home.
The advantages of Home equity loans are:
- Fixed Interest on home equity loans is fixed for the life of the loan.
- Possible tax-deductible interest up to $100,000 if money is used to improve the property.
- Lower interest rates for home equity compared to unsecured forms of borrowing such as personal loans or credit cards.
- Long repayment terms can be as long as 20 years, due to low-interest rates the monthly loan repayments are affordable.
The Disadvantages of Home equity loans are:
- The amount owed to the bank increases, therefore higher monthly payments if the home’s equity is unlocked
- Applying for a new home equity loan and an existing home loan have costs and fees. Consult a financial adviser or qualified mortgage broker to assist.
There are two main types of home equity loans: fixed-rate loans and home equity lines of credit (HELOCs).
What is a Home Equity Loan?
Home equity is the value of a homeowner’s interest in their home. In other words, it is the real property’s current market value less any claim or legal right against assets that are attached to that property.
A home equity loan is a loan for a fixed amount of money, secured through the home property. The loans are paid with equal monthly payments over a fixed term, just like an original mortgage. Failure to repay the loan as agreed can lead to foreclosure on the home.
How does Home Equity Loan Work?
The stages of a Home Equity Loan are:
- Calculate the amount of equity available in your property using the estimated market value of your home, less the balance of your current loans secured by the property.
- Work out how much equity is required – for example, that you have $150,000 worth of equity in your property. However, the number of additional repayments you can afford based on your income and expenses work out to be $50,000; then realistically that’s the amount you would proceed to unlock, rather than the full $150,000 that’s available.
- Review your loan options – during this process start researching and assessing home loan options with a Mortgage Choice broker. Consider factors such as interest rates, fees and features against other options from your current lender or other lenders in the market.
- The product you choose and the amount of equity you are looking to access may result in various fees and costs for accessing equity
- Loan application and settlement – The mortgage Choice broker will get the application process underway and provide support at every step to settlement.
Most lenders want to retain at least 20% of the property’s value as a form of security on a mortgage. If you want to use your home’s equity but still have a balance of more than 80% of the property’s value, you may be required to pay for a lender’s mortgage insurance (LMI). Lenders have different policies on the number of home equity loans.
You can calculate the amount you are allowed to borrow using this formula: (Home’s Value x 80%) – Mortgage Balance = Accessible Equity
Because so much of your monthly payments go to interest at the beginning of the loan term. It often takes about five to seven years to really begin paying down the principal. Plus, it usually takes four to five years for your home to increase in value enough to make it worth selling.
Monthly payments are based on the amount of money borrowed and the current interest rate. HELOCs typically have a variable interest rate, some lenders may convert to a fixed rate for the repayment period.
How to Apply for a Home Equity Loan?
Completing an application for a home equity loan may only take 20 to 30 minutes. It may take a lender anywhere from a day to a few weeks to process and approve your application which may be affected by your level of equity, financial situation, and whether or not your lender needs to organize a valuation of the property.
Requirements for a Home Equity Loan are:
- Have at least 15 percent to 20 percent equity in your home.
- Have a good credit score.
- Have a debt-to-income ratio of 43 percent or lower.
- Have sufficient income.
- Have a reliable payment history.
What is needed for a Home Equity Loan?
To qualify for a home equity loan you should have at least 20% equity in your home. The equity amount determines how much you can borrow.
The formula for equity in your home’s worth ($200,000) minus your down payment (20 percent of $200,000 which is $40,000).
A 15 percent to 20 percent equity in your home is important in the event that the real estate market experiences a downturn and the value of your property declines to a level much closer to the outstanding balance you owe on the mortgage. If you max out your financing, selling your home could be more difficult.
What is the Current Interest Rate on a Home Equity Loan?
Home Equity Loan is a type of debt specifically consumer debt. It enables the homeowners to borrow as opposed to their home’s equity. The amount of the loan is based on the home or property’s present market value and the homeowner’s mortgage remaining due to differences. It is also usually a fixed rate while on the other hand, HELOCs or Home Equity Line of Credit are typically at variable rates.
The Average Interest Rate on a Home Equity Loan is around 5.94% and the average rate ranges from 3.25% to 7.94%. While on the other hand, the average interest rate for HELOC is 3.88% with the average rate ranging from 1.74% to 6.85%.
A home equity line of credit also called HELOC is a form of revolving credit in which your home serves as collateral. You will be approved for an amount of credit that represents the maximum amount you can borrow. Payments have a variable interest rate and a minimum payment due each month based on the amount of the credit line you have used. You will be required to pay off your home equity line in full when you sell your home
Do Home Equity Loans Have Higher Interest Rates?
Yes, Home Equity Loans have higher rates. If a home goes into foreclosure, the lender holding the home equity loan does not get paid until the first mortgage lender is paid. So the home equity loan lender’s risk is greater, which is why these loans carry higher interest rates than traditional mortgages.
What are the Advantages of Home Equity Loans?
The property you’re borrowing against provides the lender with a high level of security because home loan interest rates are generally going to be lower than those associated with other types of credit products, credit cards and personal loans.
Another advantage of a home equity loan is that you can usually use the funds for almost any potential purpose, giving you flexibility. When using a home equity loan for investment purposes for example to invest in property, then it may become tax-deductible.
The advantages of Home Equity Loans are as follows:
- Low-Interest Rate: Since home equity loans are backed by your house or property, they often have lower interest rates than unsecured loans like credit cards or personal loans.
- Fixed Interest: As mentioned earlier, the interest for Home Equity Loans is usually a fixed rate for the duration of the loan, unlike HELOC which has a variable interest rate that can change at any moment.
- Long Repayment Periods: Home equity loans can have payback durations of up to 20 years and we can say that the monthly instalment can be very affordable.
- Possibility of Interest deducted from taxes: If you use your cash or your money in order to enhance the property used to secure loans, then you may be able to deduct the interest paid on the loan up to $100,000
.
What is the Downside of a Home Equity Loan?
Accessing equity is done by increasing how much you owe, so if you increase your home loan your repayments will increase. Borrowing allows you to invest money you wouldn’t normally have without saving the funds, but it also means that if the investment doesn’t give the return that you expect, or you make a loss on your investment, then the loss will worsen by having to pay interest on the funds in the first place. If the loan is not repaid quickly then it can lead to excessive interest.
Is there an Appraisal with a Home Equity Loan?
Lenders use appraisals to determine a borrower’s loan-to-value ratio. To determine your loan-to-value ratio, divide the current loan balance by the appraised value of your home. For example, if your loan balance is $150,000 and an appraiser values your home at $450,000, you would divide the balance by the appraisal and get 0.33, or 33 percent. The lender also does an appraisal to protect itself from the risk of default.
Are Home Equity Loans Tax Deductible?
Yes, a home equity loan and Interest on a HELOC are deductible if you use the funds for renovations to your home. A home equity loan or HELOC can be a source of funding when you want to make home improvements. The tax deduction for the interest you pay is an additional advantage.
Does Home Equity Loan Increase Property Tax?
Yes, home equity loans increase property tax. The funds you receive through a home equity loan or home equity line of credit (HELOC) are not taxable as income, it’s borrowed money, not an increase in your earnings. In some areas, you may have to pay a mortgage recording tax when you take out a home equity loan. This is determined by your state, county or municipality and based on the loan amount. The more you borrow, the higher the tax.
How long do you have to Pay Back a Home Equity Loan?
It takes 5-20 years to pay back a home equity loan. The reason for the time period depends on the monthly payment amount you can comfortably afford and to maintain a comfortable cash flow.
Do you Make Monthly Payments on a Home Equity Loan?
Yes, payments on a Home equity loan should be paid each month non-stop until you pay it all. You repay the loan with equal monthly payments over a fixed term, just like your original mortgage. If you don’t repay the loan as agreed, your lender can foreclose on your home.
How much is Closing Cost on a Home Equity Loan?
The average closing costs on home equity loans and HELOCs can sum up to 2% to 5% of your overall loan cost. A real estate transaction is a complex process with many players involved. Some loan products require certain inspections beyond the basic inspection. Then there are property and transfer taxes, as well as insurance coverage and various additional fees.
Closing costs for a HELOC are often a bit lower than the costs of closing a primary mortgage. HELOCs tend to be more flexible in terms of how much you can borrow and how soon you must repay the borrowed amount. Sometimes HELOCs can charge additional fees (that home equity loans do not charge) to compensate the lender for this flexibility.
Can You Sell Your Home If you Have a Home Equity Loan?
No, you can not sell your home if you have a home equity loan. You will have to pay off your HELOC in full before you can close on the sale. The HELOC is tied directly to your house, and if you no longer own the home, you can no longer use it as loan collateral. The HELOC lender will not release its lien on the land records unless that loan is paid off in full.
Can You Borrow Money Anytime with a Home Equity Loan?
Yes, you can get a lump sum of cash upfront when you take out a home equity loan and repay it over time with fixed monthly payments.
- Home equity loan: A home equity loan is dispersed in a lump sum making it a good choice for those who know exactly how much they need to borrow.
HELOC: A HELOC is a revolving line of credit similar to a credit card. You can borrow from a HELOC as needed during its draw period, which usually lasts about 10 years. After that, you enter the repayment period.
Benefits to a HELOC include the fact that you are only responsible for repaying what is borrowed.
Can You Move If You Have a Home Equity Loan?
No, but you will have to pay off the HELOC when you sell your primary residence. The HELOC lender made this money available to you based solely on the equity in your house. If you were to default by not making payments, the lender would be able to foreclose on the property.