Home equity loans are often referred to as second mortgages, second mortgages at times can carry a negative connotation but home equity loans aren’t always second mortgages and can in fact be used in very positive ways for many different reasons. The most popular uses for home equity loans are home remodeling, debt consolidation, starting a business and putting your children thru college. When deciding whether or not home equity loans are right for you there are a few factors that you need to look at first. The first being does your home have enough equity for you to borrow against it. Those recent homebuyers who put little down on their home and have seen home values remain stagnant this hurdle could be what eliminates the possibility of using home equity loans. When calculating what equity your home may hold you need to look at
1. What is the amount of the principal owed?
2. What is the current value?
3. What criteria does my lender look at concerning loan-to-value percentages?
Once you’ve gathered this information you can get a better idea of an amount you can borrow, for instance you owe $120,000 towards principal and your home is currently valued at $200,000 and your bank will lend up to 80% of the value. So how do you calculate the amount of equity you can borrow? Multiply .80 X 200,000 which equals 160,000 minus the amount owed towards principal which is 120,000 leaving you with 40,000 in available equity.
Home equity loans come in different forms and there are a few factors to look at before deciding which one is best fit for your need. The first and most popular is the home equity line of credit. The home equity line of credit offers very flexible terms usually consisting of several repayment options such as interest only, fixed payment amounts or a percentage of whatever the outstanding balance is such as 1.5% or 2% of the principal balance. Home equity lines of credit have the added benefit of being revolving, meaning they can be established and not used until needed or used paid off and remain dormant until the borrower needs to access to the cash. The funds can be instantly transferred to an account and access is immediate. The third benefit is the ability to role balances into what’s called a Fixed Rate Option. This allows you to have a fixed interest rate and a fixed payment however the fixed rate is often considerably higher than that of the variable rate that you would have on the line of credit. The last benefit and what is sometimes the most important for many borrowers is the ability to write off interest on your tax return. This isn’t always the case and to know if you would qualify it’s always best to consult a licensed tax professional. One factor to consider when deciding whether or not a home equity loan is right for you is the variable rate. Most have a variable rate that is based on the prime rate. Prime rate is the prime lending rate that is published in the Wall Street Journal. This can change at any time and affect the interest associated with the line of credit. Most lenders place a margin on prime to determine what rate of interest to charge, for instance if prime is at 3.25% a lender might place a margin of 1% on the line of credit making the rate you pay 4.25%. This can make borrowing very cheap but if the Fed determines that prime needs to be increased your rate can literally change overnight. The second factor to consider with the revolving home equity line of credit is that your lender or bank has the ability to change your limit based on what they value your home at. Let’s say that your home was originally valued at 200,000 and you established the line of credit at 40,000 but your bank has all of a sudden determined that your home is no longer valued at 200,000 and it’s now valued at 170,000. Using the same formula from above the lender would decrease the limit from 40,000 to just 16,000.
The other side of home equity loans are the fixed term loans. These tend to have higher interest rates and are far less flexible but they allow the borrower to have peace of mind that their terms and rate will stay the same thru out the life of the loan. These types of home equity loans also tend to have more fees associated with them.
The best thing a borrower can do when considering home equity loans is to shop around and then shop around some more. Depending on what you want you should be able to find a lender that has something that will tailor to your needs just remember not all home equity loans are created equal and neither are the lenders.