What Are Home Equity Loans?

Home equity loan is a kind of loan that enables the borrower to borrow some money from the money lender on the basis of home equity. Equity is the part of the property that the owner possesses, and it is determined using the current fair market value of the home minus the outstanding balance on the mortgage.

Home equity loans enable a homeowner to borrow money against this equity for purposes like home renovation, debt pay off, purchase of cars, other necessities, tuition fees among others. Generally, such loans also attract lower interest charges as the property is used to guarantee the loan.

Everything About Home Equity Loans

Unlike the home equity line of credit, the home equity loan works where the lender takes a second position behind the first mortgage. The loan amount is a proportion of the current appraisal value of the home less any mortgage associated with the first position. The sum total of all liens should not exceed 80-90% of the market value of the home.

For instance, if the house is worth $500,000 and you have a mortgage of $300,000, you have $200,000 in equity. For instance, if you are using an 80 loan-to-value, it means that you can borrow up to $160,000 in home equity loans. This leaves at least 20 equity to safeguard the interest of the lender in a situation where the value of the homes depreciates.

Home equity loans have fixed/adjustable interest rates, terms of 10-30 years and equal monthly installment payments as a first mortgage. Interest as well as principal payments are made on monthly basis until the loan is fully repaid. These installment payments are not tax-deductible unless the loan proceeds are to be used for home improvements or other tax-deductible uses.

Another possibility is home equity lines of credit (HELOCs). HELOCs are closer to credit cards with variable rates and draw periods that allow you to borrow only the amount you need and pay interest only on it.

Advantages of Home Equity Loans

There are several potential benefits to tapping home equity with a loan:

Home equity loan rates are very low, currently standing at anywhere between 3-6% for prime borrowers. It gives relatively inexpensive recourse to funds for large purchases.

Fixed payments - Home equity loans are provided at fixed interest rates and therefore the regular payments you make do not alter. This makes it easy to accurately estimate the budget required each month.

Affordable payment plans – clients are allowed to pay back the loans in a long time of up to 30 years. This is quite different from other forms of financing like personal loans or credit cards that have short repayment durations.

Tax credit – Loans incurred for home improvement, repair or remodeling of one’s home attract interest which is tax-deductible. This can result in a significant reduction in tax bills each year.

Home equity loans enable you to access the value of your home without having to sell and move out. The funds can be utilised to enhance your existing home or to work toward other monetary goals.

Establish credit – This too may help you build credit provided that the payments have been made on time and as agreed. It can also help to negotiate for better rates on future loans.

Potential Drawbacks

While home equity loans offer homeowners many perks, there are also some potential drawbacks to consider:

Closing costs – There are the costs you will incur when signing the home equity loan agreement. This includes fees for appraisals, title searches, loan processing and amongst others. This can be between 2-5 times the amount of the loan that has been borrowed.

Early repayment penalties – With some home equity lenders, there is a penalty for paying off the loan before the agreed number of years. It is recommended to get this cleared before moving to it to avoid being shocked.

Long pay back period-Though it is preferable to have a 20 or 30 years’ period of repaying the money, it only means that one will be paying more interest on the money repaid compared to when it is repaid within a shorter period.

Foreclosure – If you do not make payments on a home equity loan on time, you may face the risk of foreclosure. The worst-case situation in this case is that you lose your house.

Reducing home equity - E. g. , if house prices decline, then one may find him or herself paying more than the value of the house. This will make it difficult to sell or refinance until values recover to the levels it was before the bubble burst.

How does one become eligible for a Home Equity Loan?

The home equity loan has a qualification process, which involves credit scores, income, the history of the existing mortgage and amount of equity to approve the loan as well as the terms of the loan.

Here are the key requirements lenders look for:Here are the key requirements lenders look for:

Credit Score – Applicants with lower scores of 600 and above are welcome but those with scores well above 720 are offered the best rates. Debt reduction and fixing errors in the credit report are some of the ways that can assist in improving scores.

Loan-to-Value Ratio – This really means that the proposed loan cannot be more than a certain percentage of the current value of your home and must not be more than 80-90% of your home value once you factor in any existing mortgage. The remaining 10-20 equity safeguards the lender.

Income and Debt-to-Income Ratio – Debuted income to meet the new monthly payment comfortably must be recorded. Total debt payments including the home equity loan cannot in any case, exceed forty three of the gross monthly income of the borrower.

Home Equity and Appraised Home Value – You require significant tappable home equity, as well as a satisfactory appraised home value to secure a generous amount of credit that would be beneficial for you.

Mortgage repayment record within the last one year – This is a standard that most lenders have set whereby the borrower should have a clean record in repaying their mortgages within the last one year. More minor errors that are made earlier may be tolerated with reasonable provocation given.

Minimum Ownership Period – The normal requirement is that you should have held the title to the property for at least 6-12 months in order to access a home equity loan.

Home Equity Loan Application: A Step by Step Guide

If your finances indicate you may qualify, here are the next steps to formally apply:If your finances indicate you may qualify, here are the next steps to formally apply:

Verify home value – Go online to use a home value estimator or hire a professional appraiser to determine your houses current value. Approximately, this shows how much equity is available.

Review charges – Origination fee, other costs to start the loan, including interest and regular amount to pay is important in terms of financial planning.

Choose a loan type - Mortgage loans, home equity loans, debt consolidation loans, and other types of loans are available for comparison. Consider rate, term, fee and other variables as ways in which they may be differentiated. Local banks and credit unions may be the most affordable option.

Loan application – Complete the formal application process by supplying financial, income, employment and property documents to support your application. This leads to the underwriting process.

Undergo appraisal and inspection – A competent appraiser is hired by the lender to assess the value of your home. Inspections evaluate condition, electrical, plumbing and many more. Any repair works that may be necessary must be done.

Closing disclosures – Be specific with terms, costs, and legalities in the closing documents. This is a very important aspect to consider since the act of signing seals the deal and makes it binding to all the parties involved.

Pay off the loan – Provide any other documents required for the home equity loan and pay any closing costs to complete the loan process. This means that the lump sum of approved funds will be paid directly to you.

It is crucial to make the right decision about whether getting a home equity loan is right for your personal and financial life. If qualification requirements are clear, the homeowner has a significant amount of equity and is able to make the monthly payments in the long run, borrowing from home equity is cheap since it offers funds for major expenses such as remodeling, debt payoff among others. This will enable one to evaluate various programs in order to arrive at the most suitable loan program.