Utilizing your Home Equity
Risky as it may sound, plenty of homeowners have made good use of home equity loans by upgrading their homes, paying for a child’s college tuition, or paying off crippling debts or medical expenses. It can be tricky to figure out whether you’re a good candidate for a home equity loan or home equity line of credit, so here are a few questions to ask before you start shopping for lenders:
Has the value of my home increased, or decreased?
If the value of your home has decreased, you won’t be eligible for a home equity loan or line of credit. Essentially, if you owe more on your home than it’s worth, there is no value to borrow against. Most lenders will not loan more than an amount that causes your total home mortgage debt to equal 85 percent of the home’s value as a home equity loan.
Do I need the funds for a large, one-time expense?
Home equity loans are best for homeowners who need to finance big expenses, since they have fixed interest rates. You’ll get a single disbursement, making them popular ways to reconfigure debt or pay for extensive remodels. If you need funds that are available on demand, more like a credit card, a HELOC is probably more appropriate, since it’s a credit line that you use as you need it -- the only catch is that you’ll likely have an adjustable interest rate.
Do I have good credit?
There are no hard-and-fast rules for creditworthiness on a home equity loan, but it’ll be far easier to secure a home equity loan if your credit score is higher on the spectrum. The reason? If you default, your first mortgage gets higher priority than the home equity loan or HELOC that’s in the second position, meaning it’ll get paid off first -- making the second mortgage the riskier loan from your bank’s perspective.
How Home Equity Works
Home equity works roughly like this: first, an appraiser determines how much your home is worth. Let’s say it’s worth $250,000. Since lenders typically won’t loan more than about 85 percent of your home’s value in the form of a home equity loan or HELOC, you’ll multiply $250,000 by 0.85 to determine your maximum loan amount. That comes out to $212,500.
Now, say you still owe $70,000 on that same home. Since your lender is going to expect you to pay the primary mortgage as well, they’re going to subtract that $70k from the amount they’ll fund your home equity loan. That takes you down to $142,500. Don’t spend it all in one place, ok?
The two main types of home equity financing are Home Equity Lines of Credit (HELOCs) and Home Equity Loans (HELs).
Home Equity Loan (HEL)
A home equity loan is distributed as a lump sum at the loan’s origination. It’s a long-term loan that you pay off over the course of several years and often offers the advantage of a fixed rate of interest, though it may be higher than your primary mortgage.
Home Equity Line of Credit (HELOC)
When you need to use your home’s equity for smaller projects here and there over a long period of time, a HELOC is probably a lot more appropriate credit tool. With a HELOC, you’re given a total credit line that you can use as you need it. You never have to borrow the full amount, and you can pay it off and reborrow as often as you’d like. They do frequently come with adjustable rates, however.
Although there’s some risk involved in borrowing against the home equity you’ve spent so much time accumulating, there are times when using a home equity loan is the smartest move you can make. If you’re unsure if a home equity loan or HELOC is right for your family, contact us at Home.Loans. We’re just posting pictures of our lunches to Instagram waiting for you to reach out.