Introduction Homeowners use home equity loans and lines of credit to pay for home renovations, to pay off credit card balances or for other substantial expenses. A home equity loan enables you to borrow money against the value of your home. But wait, how exactly does home equity loan work with the current Mortgage out? Does it alter your mortgage rate or change the terms of your mortgage in any way?
Home equity loan is a loan that is got by using the value of your house or home as security. A home equity loan is a second mortgage that enables the owner of a property to borrow money based on the current value of the home. Equity means the current value of your home minus the outstanding balance of the mortgage. So, for instance, the value of your home is $300,000 and you had an original mortgage of $180,000, you will have an equity of $120,000. Using home equity, you get cash in a lump sum, unlike home equity line of credit which allows you to borrow cash as you need it.
The Difference between a First Mortgage and Second Mortgage The first mortgage or primary mortgage is the initial loan that you took out to buy your house. This is the mortgage that has the first priority in the case of your home in the event that you fail to pay your debts. Both a home equity loan and a home equity line of credit are called second mortgages. The first mortgage has right of first refusal in regards to loan repayments. In case you fail to pay the loan, the first mortgage lender is paid first from the proceeds of a foreclosure auction. The second mortgage is paid next if any balance will be left.
Does It Change the First Mortgage?: A second mortgage does not change the first mortgage in the legal sense but it does alter several aspects of it. Most importantly, a home equity loan has no direct impact on your first mortgage since the terms of the two are distinct. It does not apply to your first mortgage loan interest rate, payment, period of the first mortgage loan, or any other term. It is a completely different loan that you get on the equity of your home which has its own interest rate and monthly installments. The first mortgage is paid with one sum and the home equity loan is paid with another sum of money.
However, both loans do combine to add to the total debt at your disposal as well as the monthly costs of housing. However, even if home equity loan rates are relatively low, the extra loan installment can be costly to your household. Ensure that you are capable of handling the higher monthly repayments before putting extra cash on your real estate.
It is important to always carefully look at the details that are usually provided when going for a home equity mortgage, so that you can know the cost, fees and the terms which you are agreeing to pay in the long run. Visit different lenders’ offices and compare the interest rates and charges. Variable rates and fixed rates must also be compared cautiously.
Impact on the Current Mortgage Loan-to-Value Ratio
However, in most circumstances, a home equity loan does not affect the loan-to-value ratio on the first mortgage in the short term. This ratio shows the extent to which the amount of the first mortgage debt you still need to pay bears to the current appraised or market value of the house.
However, you should note that over the extended period, the combined loan amounts necessarily raise your total loan to value ratios. This is a good measure if you are interested in applying for a second mortgage or if you decide to move and sell your home. If you are indebted beyond the value of your property it becomes almost impossible to secure a loan. To ensure that home equity and home value are healthy, one should try to pay down most of the home equity debt.
When Can a Home Equity Loan Change Your First Mortgage? In a few special cases, the second mortgage can change the terms of the first:In a few special cases, the second mortgage can change the terms of the first:
Cash-Out Refinancing: When you withdraw cash during the mortgage refinance process, you are essentially refinancing your first mortgage with a new and larger loan. The monthly payments, interest rate and loan amount are reset for the coming month.
Cross-Collateralization: It is true that some of the second mortgage lenders may demand that your first and second loan be used as cross collateralized. This gives the lender the opportunity to foreclose the first mortgage in case you fail to pay the home equity loan. Be very cautious if you encounter this clause because it is a trick to get you to agree to other unfavorable terms.
Call Due Provisions: There are some mortgages that are characterized by a call due provision meaning that the lender has the right to demand full payment of the loan in case of the breach of some specific conditions such as taking another mortgage. This provision should especially be avoided in your first mortgage if you are considering home equity financing.
The moral of the story is that for practical purposes, a stand-alone Home Equity Loan is generally not a factor that affects or threatens the consumers’ first mortgage. But we do feel that with higher total debt, your overall financial profile does shift. Both loans should be considered as you deal with your overall costs of housing as well as your debt.
