Home Equity loans are a good way of obtaining credit, provided there is still equity in your home. The reason for the “provided there is still equity in your home” caveat is that the downturn in the economy has left many homeowners owing more than their homes are worth.
A Hypothetical:
Let’s say your home loan is for $225,000. During the 10 years you’ve been living in it, the property value increased by $300,000, which makes it now worth a whopping $525,000. You have paid – to date – a total of $100,000 on the note. If you subtract what you’ve paid on the loan from what you still owe, you get $125,000. Now subtract what you owe ($125,000) from what your home is currently worth ($525,000) and you get the amount of equity you currently have in your home, which is $400,000.
So, technically, $400,000 is the amount that you can borrow from the equity in your home. Of course, your loan-to-debt ratio (how much usable income you have left over after bills) will be the determining factor on what you can borrow. Loan requirements are stiffer now; so if you got your first mortgage in the days when any warm body with a pulse qualified, you are going to have to take a hard look at what you owe – against what you make.
Home equity loans often have lower interest rates than personal loans. There is no limitation on what you use a home equity loan for. Additionally, if you sell your home, the home equity loan must be paid off at that time.
A home equity loan is secured against your home, meaning that if you default on the loan, your home will go into foreclosure, and will lose it.
Home Equity Loans:
If you do feel that you can qualify for a home equity loan, then you have three main choices in the type of home equity loan you can get:
Second Mortgage:
A second mortgage is a lot like a first mortgage, with an appraisal, fees, points, loan origination fee, etc. On many second mortgages, the payback period is shorter than that of your original loan. You will need to shop around for the best interest rate and lock that in, and not borrow more than you can afford (even if the lender says you can). Only you know what payment amount will be comfortable for you.
Home Equity Line of Credit:
The second option in loan types when getting a home equity loan is a home equity line of credit (HELOC). This type of loan is secured against your home, just like a second mortgage; however, with a HELOC, you are given an amount that you can borrow, but you don’t have to borrow it all at once. A HELOC is a great loan when putting kids through college because you can withdraw the amount you need – when you need it.
Depending on the terms of your HELOC, there may be a minimum amount that you have to withdraw each time you use this line of credit. The lender usually gives the borrower a book of checks or a special credit card for withdrawing funds from his HELOC.
A favorable aspect of a HELOC is that it is good over time:
Let’s say that college tuition for your child is $40,000 per year. With the HELOC, you borrow the $40,000, one year at a time, in case Junior drops out or switches majors and decides to transfer to a different college.
Once you withdraw against your line of credit, you begin making payments on it right away. This means that you will be lowering the balance on your HELOC from the beginning.
Reverse Mortgage:
If you are over the age of 62 and live in your home more than 50% of the year, you may qualify for an equity loan called a reverse mortgage. In a reverse mortgage, you get a payment each month from the equity in your home. If you are living on Social Security and/or a pension, this may be just the loan for you. Also, if your house is close to being paid off, a reverse mortgage lender will oftentimes allow you to borrow a lump sum to pay off the remainder of your first mortgage.
After you die, your home will be sold to pay off the reverse mortgage.
When considering a reverse mortgage, it is important to weigh that against the idea of selling your house now, buying something smaller, and using the profit from your first home to help pay your living expenses.
A reverse mortgage is dependent upon the economy and how much equity you have in your home.
Points to Remember:
Many factors come into play when weighing the pros and cons of obtaining a home equity loan. You have to consider the interest rate, amount of payment, how much you want to borrow, the points, fees and other charges. The amount of time you have to pay it back is another big consideration.
These days, though, the main thing to consider is where you stand in today’s economy. You still may have equity in your home, but it won’t be the amount you had five or six years ago (when you thought that you were sitting on a gold mine). Whether or not you decide to get a home equity loan will depend upon job security and whether you can qualify for the loan under today’s more stringent borrowing requirements.
SOURCES:
Pritchard, J. (n.d.). Home Equity Loans. About.com. Retrieved on January 31, 2011, from http://banking.about.com/od/loans/a/homeequityloans.htm
Making Home Equity Work for You. (2011). Bankrate.com/MSN Money. Retrieved on January 31, 2011, from http://articles.moneycentral.msn.com/Banking/HomeFinancing/MakingHomeEquityWorkForYou.aspx
Silverman, J. (n.d.). How Home Equity Loans Work. howstuffworks. Retrieved on January 31, 2011, from http://home.howstuffworks.com/real-estate/home-equity-loan.htm
Home Equity Lines of Credit. (2009).The Federal Reserve Board. Retrieved on January 31, 2011, from http://www.federalreserve.gov/pubs/equity/equity_english.htm
May, K. (2011). How Home Equity Credit Works. http://www.ehow.com/info_7752966_home-equity-credit-works.html