Home Equity Loans and HELOCs: An Overview
Many Americans are richer in home ownership than they were a year ago thanks to rising real estate values in markets across the country.
A home equity loan or line of credit is one way to use your home's cash
Both types of loan are home-secured so they charge much lower interest rates than other loan options – like personal loans or home loans
But which of these second mortgage loans
Do you need? Or, you should consider a withdrawal refinance to replace yours
existing mortgage instead?
Review your home financing options (February 4, 2021).
In this article (jump to …)
What is a second mortgage?
A home equity loan or line of home equity (HELOC), also known as a “second mortgage,” allows you to access some of your equity without selling your home or refinancing your existing mortgage loan.
When you apply for a home equity loan or HELOC, your current equity will determine how much you can borrow.
As a refresher, equity is the value of your home minus that
You owe your mortgage. If
You own a home with $ 300,000 and owe $ 200,000 on your mortgage. You have $ 100,000 in
How home equity loans work
Like your current mortgage a home
Equity loan would be an installment loan with a fixed interest rate that pays a
Lump sum in advance. You would
Make monthly payments based on a repayment schedule to repay the loan.
But unlike yours
current mortgage – the one you bought the home with
– You could spend the money
from a home equity loan in any way.
You could even use the money for expenses
not related to your home. For example, borrowers often use home equity loans to fund larger loans
Debt ConsolidationMedical BillsCollege EducationA Home HomeHome RepairsHome Improvement Projects
A home equity loan is versatile
Financial product, but it is
important to remember yourself
cannot use the same equity over and over again. These are
secured loans, which means you
Tie up your equity as security.
When you get a home loan, a
"Lien" is created against your home and reduces your actual home equity. If you sold the house before you paid for it
A home equity loan would require you to repay both your main lender and your home
A lien also gives your lender the right to foreclose your home if you cannot repay the loan as agreed. So, as with any mortgage loan, there are risks.
Equity lines of credit work
Like a home equity loan, a home equity loan
The Line of Credit (HELOC) uses the existing value of your home to generate cash that you can
use for any purpose you want.
But compared to a home equity loan, a
HELOC has some major differences:
A HELOC is a Line of credit that you can draw and then repay repeated, similar to a credit card. Since your home equity backs the line of credit, you'll pay significantly less interest compared to a credit card HELOCs typically have variable interest rates that are linked to the key interest rateTherefore, payments are not as predictable as the fixed payments on a home equity loan. HELOC payments are also based on the amount of credit line you use each month few, if any, closing costs for HELOCs. The lender often pays the origination fee
HELOCs can extend loans as needed.
They therefore offer ideal financing for ongoing projects. Often times, borrowers can move
Money from your HELOC to a checking account within minutes.
But a HELOC will not last indefinitely. At the
At some point – usually after 5 or 10 years – the drawing period of your HELOC ends
and you need to adhere to a repayment schedule.
Some HELOC borrowers convert their lines
from loans to home equity loans when they are done drawing on the loan
How much can I borrow with one
Home Equity Loan Or HELOC?
Not all lenders offer or offer home equity loans
HELOCs. And the ones that usually limit the amount you can borrow
only part of your home's equity.
Let's take another look at a $ 300,000 house with one
$ 200,000 mortgage. The owner of this home would have a home equity of $ 100,000.
But chances are the homeowner could borrow
only about $ 55,000 of that equity through a second mortgage.
Why such a small amount? Because mortgage lenders enforce the lending requirements that limit the value of your home that can be tied in mortgages.
Calculating Your Maximum Home Equity
Loan-to-Value (LTV) calculations can be
Confusing because they apply to both mortgage loans – as your existing mortgage
as well as the new home loan or HELOC.
For example a maximum mortgage lending value of 85%
For a $ 300,000 home, the homeowner can only hold $ 255,000 in value
Mortgages ($ 300,000 x $ 0.85 = $ 255,000).
Since the primary mortgage has a $ 200,000 loan
Balance that leaves only $ 55,000 for the second mortgage.
Here is a simple breakdown of that math
from start to finish:
Home Estimate: $ 300,000 Mortgage Loan Balance: $ 200,000 Home Equity: $ 100,000 Calculate 85% of the current value of your home:
$ 300,000 x 0.85 = $ 255,000 Subtract the $ 200,000 you currently oweTotal Available Equity: $ 55,000
Not all homeowners will be
You can also borrow the maximum amount of equity available.
Other factors that affect your credit standing
Lenders look too
Factors like your credit score, credit report, and debt-to-income ratio too
Determine how much of a loan you qualify for – just like yours
bought your house.
In addition, it is assumed in the above example
You only have two mortgages – the primary mortgage and the new home loan
or HELOC. A third lien would further limit borrowing.
Because of these limits, you will likely need to build an estate
Equity in your home before you can borrow a large amount
Fortunately, increasing house values have that
Process of accumulating equity for many homeowners over the past year.
Review your home financing options (February 4, 2021).
Loan against HELOC? What is better for you?
When you are ready to borrow against your loans
probably have three options:
A Fixed Rate Home Equity Loan A variable rate home equity line (HELOC) A payout refinancing loan
Let's see how these options compare.
Put simply, a home equity loan is just another mortgage
Loan that is usually smaller than your current mortgage. You will receive the total amount you want to borrow in a flat rate and
pay it back every month.
The repayment schedule for a home equity loan is typically 5 to 15 years. Since this is an installment loan, the payment and interest rate will stay the same throughout the year
Term of the loan.
A home equity loan must also be repaid
in full when the house is sold.
Home Equity Line of Credit (HELOC)
A HELOC uses your home equity to fund a line of credit that you can
pull as needed.
You can use yours during the draw period
HELOC would love to use a credit card, but without the fear of high-yield debt
Over. You can also choose to repay the loan capital or repay during the drawing period
Make interest payments only monthly, depending on your financial situation
The draw period (typically 5 to 10)
Years) there is a repayment period of 10 to 20 years, during which you can no longer withdraw money and
must repay any outstanding balance in full with interest.
Unlike a home equity loan or HELOC,
Withdrawal refinancing replaces your existing mortgage with a brand new loan.
The new loan balance is greater than
What you currently owe and the difference will be paid to you on completion
(minus closing costs).
Since a disbursement refinance is a first mortgage (not a second mortgage), it usually offers lower interest rates than a HELOC or home equity loan. And requirements can also be milder. FHA disbursement loans are available even with a credit score of as little as 600.
Withdrawal refinancing, on the other hand, will start your loan over, so your total interest cost may increase over the life of the loan.
The long-term costs will depend on how much time you have left on your existing mortgage and how low your new interest rate is compared to your old one.
Find The Right Loan For You (February 4, 2021)
Disadvantages of home equity loans and HELOCs
When deciding between a HELOC or home equity loan, consider the pros and cons of both types of borrowing.
Equity loan professionals:
Fixed rates and fixed paymentsSimplicity of an installment loanYou can get tied to today's low mortgage ratesSingle payment is great for large projects, purchases, or debt consolidations
Disadvantages of the equity loan:
Less flexibility than a home equity line of credit (HELOC) The entire loan amount earns interest regardless of how much of it you use. Lenders may require higher credit scores than traditional mortgages. Not all lenders offer these loans. The closing costs can be higher than with HELOCs
Interest will only be charged on the amount withdrawn from the credit line. Can be repaid and reused throughout the draw period. Ideal for ongoing or not yet planned projects. Some lenders do not charge closing costs
Variable interest rates make repayment less predictable. A floating rate can add to your overall costs if the key rate increases. The line of credit ties up the equity even if you haven't drawn from it
Is Mortgage Loan Best For You?
What's Your Best Option: Home Equity?
Loan or HELOC? Jed Mayk, attorney and partner at Hudson Cook, LLP, says so
depends on your needs.
“A home equity loan might make more sense
for a borrower who needs a certain amount of money for a specific purpose, ”he says.
"This can include a home improvement project."
A home equity loan is usually one too
more suitable for needs like:
Debt Consolidation Extensive home renovation requires a great deal
PrepaymentInvestment in real estate
But a home equity loan might not be the best
Option “If you are not sure what amount you have now or in the
Future, ”says Johnna Camarillo of the Navy Federal Credit Union.
A HELOC could be more useful for them
who have to borrow different amounts over a certain period of time, Mayk says.
Examples of good uses for HELOCs are:
Regular tuition, advanced pay as you go home improvements, providing an emergency cash flow for a new business
HELOCs are best for those who don't need them
instant access to your home's equity.
“A HELOC can be used like a credit card.
It's great to have a rainy day fund if your home needs emergency repairs. "
According to Mayk, HELOCs are also popular with
People who have irregular income patterns. “This includes those who have paid a base
Salary and quarterly commissions. "
Other HELOC and home equity loans are to be considered
You need good credit
Score to use either a HELOC or a home equity loan.
“A score of 620 or less makes it difficult
to secure a (home) loan or HELOC, ”says Theresa
Williams-Barrett of Affinity Federal Credit Union. "Higher scores can
Provide access to higher loan amounts and lower costs. "
You have to be confident too
Income and job security. “A safe, constant source for
Income is very important, ”says Williams-Barrett.
Also note that home equity and HELOC interest may or may not be tax deductible. Ask a tax advisor.
Ways To Get Home Loans
HELOCs and home equity loans (sometimes also called
HELOANS) aren't the only ways to borrow against the value of your home.
Instead of taking out a second mortgage, a disbursement refinance replaces your existing home loan with a new, larger mortgage.
The new loan is used for payment
deduct from your current mortgage and the additional amount will be paid out to you
Most mortgage lenders limit the amount you can borrow on a withdrawal refinancing to 80% of the value of your home. (The exception is VA disbursement refinancing, which allows for a 100% credit-to-value ratio.)
Back to our example of a $ 300,000 house
with $ 200,000 still due on the mortgage:
Home Value: $ 300,000 Maximum Refinance Loan Amount: $ 240,000 (0.8 x $ 300,000) Subtract the existing mortgage balance: $ 240,000 – $ 200,000Maximum payout: $ 40,000 (minus closing costs)
Refinancing withdrawals has a few differences
Services. You get one mortgage payment instead of two; Interest rates are
usually lower than home equity loans or HELOCs; and if you a
If you set a higher interest rate on your existing mortgage, locking can save you a lot
in a lower rate or a shorter term.
“This is an attractive option if you do
lower your interest rate, ”suggests Camarillo.
Note, however, that refinancing begins
Your loan is over on the first day. When you're almost done, pay off your electricity
A mortgage, home equity loan, or HELOC might make more sense.
Convertible HELOCs come with an additional
Feature – the conversion option.
Sometime during the life of the loan
You could convert your floating rate HELOC into a fixed rate home equity loan.
Your HELOC may already have a conversion
Possibility; Some even give you more than one chance to be converted during the lifetime of
Remember, this may not be very much. The fixed-rate repayment period after the conversion can be longer and the interest payments can extend over a longer period. Sometimes a floating rate is preferred to a fixed rate. And a convertible HELOC may have higher fees.
However, this is an option worth considering if you want a hybrid between a variable rate HELOC and a fixed rate HELOAN.
When shopping for a HELOC with a
Conversion Option, Ask Lenders These Questions:
Is there a conversion fee? If so, how much does it cost? Can I use the remaining credit after a conversion on the line? Will the loan be converted into a new fixed loan (e.g. with a term of 30 years) or is the remaining amount amortized over the remaining term of the existing loan? How many times can I convert? How many times can I convert? What determines the new fixed rate?
As always, make sure you fully understand the terms of the loan and the total long-term costs before signing up.
Equity Loans vs.
What is Home Equity?
Home equity is that part of the value of your home that you own. In other words, it is the value of your home that you don't owe a lender. To calculate your equity, subtract the amount you owe on your current mortgage from the market value of your home. The amount of equity in a home will fluctuate over time as you repay your mortgage loan and the value of the property increases or decreases.
How Much Can You Borrow Against the Equity in Your Home?
Homeowners can typically borrow 80–90% of the estimated value of their home on a home equity loan, minus the debt on their first mortgage. This amount can vary based on creditworthiness.
How do home equity loans and HELOCs work?
A home equity loan is a second mortgage. Just like your primary mortgage, the value of the home serves as collateral for the lender. Home equity loans are repaid in installments of the principal and interest over a fixed repayment period. A home equity line of credit (HELOC) is a little more complex. You can withdraw from the line of credit and make payments only for the amount withdrawn. As with any mortgage, if the loan is not paid back and the home goes into foreclosure, the house could be sold to pay off the remaining debt.
Are Home Equity Loans and HELOCs a Good Idea?
A home equity loan can be a great way to convert the equity built in your home into cash, especially if you are investing that money in renovations that add value to your home. But always remember that you are putting your home at risk. If property values go down, you could end up owing more than your home is worth. Then, if you decide to move, you may lose money selling the home or you may not be able to move.
Will A Home Equity Hurt Your Credit?
Home equity loans can have an impact on your credit score. However, home equity lines of credit (HELOCs) tend to have a greater impact on credit scores. Whether the effects are positive or negative usually depends on how much you owe compared to your available credit limit.
What creditworthiness is required for a home loan?
Most lenders require a minimum loan value of 620 for a home loan. Other lenders may ask for scores of up to 700. As with other mortgage loans, the better your credit rating, the better your interest rate and loan terms.
Are Home Equity Loans Tax Deductible?
The interest paid on a home equity loan, or HELOC, may be tax deductible if the funds are used to "buy, build, or significantly improve" your home. If the funds were not used for any of these purposes, interest is not tax deductible. In addition, you can only deduct mortgage interest if you report your tax deductions instead of the standard deduction. If you are unsure how to handle your taxes, contact a tax advisor.
Is there a penalty for early repayment of a home equity loan?
Most home equity loans have no prepayment penalty. However, some HELOCs have penalties that recapture closing costs on loans that your lender may initially have waived.
Are You Considering A Home Loan?
Many with increasing house values
Homeowners have historically gained a lot of equity in their existing homes
a few years.
Home equity loans and HELOCs can be
inexpensive ways to unlock this equity without replacing your existing mortgage.
Compared to other forms of borrowing like high yield credit cards or credit cards
Unsecured personal loans, these loans can offer attractive interest rates.
But you are putting your home at risk
to get these low prices. You owe it to yourself to use this credit power
And look around to get the best
Rates with Today's Top Lenders.
Check your new rate (February 4, 2021)