What Are Home Equity Loans And Lines Of Credit
A home equity loan is a second mortgage that allows you to borrow against the equity youve built in your home. The loan is disbursed in a lump sum and you repay it, plus interest, over a set term.
A home equity line of credit is a revolving credit line that works similarly to a credit card. You pay only for what you use, plus interest. HELOCs have a set draw period during which the credit line is available for use. When it switches to the repayment period, you can no longer access the credit line.
Home equity loan interest rates are typically fixed while HELOC interest rates are often variable.
The rates on both home equity loans and HELOCs are based on your:
- Debt-to-income ratio
- Loan-to-value ratio
Having a lower LTV ratio or higher credit score may lead to more favorable terms, while a higher DTI ratio might warrant a higher rate or make it harder to get approved for a home equity loan altogether.
If youre using a home equity loan or HELOC to pay for improvements to your home, the interest you pay is generally tax-deductible through the mortgage interest deduction. Interest paid on a home equity loan or HELOC for any other purpose, such as buying an investment property or consolidating debt, isnt tax-deductible.
What Is A Cash Out Refinance
When you get a cash out refinance, you get a new mortgage. You pay off your current mortgage and replace it with a new one for a higher amount, taking out the difference in cash as a lump sum at closing. You get all the money at one time with a cash out refinance and cannot get additional money in the future from the loan. Because a cash out refinance involves getting a new mortgage, you will need to complete a new application, document your current finances, and pay a new set of closing costs.
Cash out refinances can be good choices if you know how much money you need. If you want to consolidate higher interest debts and loan payments you might choose a cash out refinance. If you are planning to complete home renovations and improvements, and know how much they will cost, you might also choose a cash out refinance. You may pay for college with cash out refinances too.
An advantage of cash out refinances is that you can also change the terms of your mortgage with them. For example, when interest rates are falling, you can use a cash out refinance to get money from your home equity and change your interest rate at the same time. You can switch from an adjustable rate to a fixed rate mortgage or change the number of years you have to pay back your mortgage with a cash out refinance too.
Pros of a cash out refinance:
Cons of a cash out refinance:
Repaying A Home Equity Loan
After you receive your loan amount, get ready to start paying it back. Your monthly payments will be a consistent amount throughout the term of your loan and include both principal and interest.
You may think its best to choose a shorter loan term, so you can pay off your debt faster. Remember, a 10-year term will have higher monthly payments than a 15- or 30-year term.
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Why Mortgage Rates Differ From Advertised Rates
In mortgage lending, what you see is not always what you get. The mortgage rates that are advertised by lenders aren’t always available to average consumers. Even so, there’s a very good reason not to ignore them. Understanding the assumptions behind advertised mortgage rates can help you budget your home loan more effectively. Throughout most of 2010, Freddie Mac’s Primary Mortgage Market Survey has reported average mortgage rates in the 4 to 5 percent range. At the same time, lenders have been pitching rates in the 3 percent range and sometimes even lower. What gives? It comes down to this: Freddie Mac’s survey is based on actual mortgage loans, while advertised rates are based on assumed conditions and qualifications. A perfect world Lenders develop advertised mortgage rates based on the best possible conditions, which may or may not apply to your particular situation. If you’re reviewing advertised mortgage rates online, you can usually locate fine print that describes the specific assumptions involved. Each lender defines these independently, but some common parameters are:
- a minimum credit score of 740
- a loan amount of $350,000
- 30-year, fixed-rate mortgage
- maximum loan-to-value of 60 percent or 80 percent
- 30-day rate lock
- establishment of an impound account for taxes and insurance
Who Can Benefit From A Second Mortgage
Second mortgages are often recommended as a short-term financing solution. The high interest rates along with the large penalties and fees can discourage individuals from taking a second mortgage. In addition, an applicant must have sufficient equity in their home in order to support a second mortgage.
Since income and credit history both play an integral part in the qualification process of a second mortgage, many Canadians 55 plus or Canadians who are approaching retirement may not qualify.
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What Are The Minimum Requirements
Many lenders have fixed LTV ratio requirements for their home equity loans, meaning you’ll need to have a certain amount of equity in your home to qualify. Lenders will also factor in your credit score and income when determining your rate and eligibility.
Minimum requirements generally include a credit score of 620 or higher, a maximum loan-to-value ratio of 80 percent or 85 percent and a documented source of income.
Home Equity Loan Alternatives To Consider
A home equity loan can be attractive if youre looking for ways to borrow money, but there are also other ways to get cash if you need it. So before you pull the trigger on a home equity loan, you should also consider the following:
A personal loan lets you borrow a fixed amount of money with a fixed monthly payment and a fixed repayment term. However, personal loans are not backed with collateral, so you dont have to have a specific amount of home equity or any other collateral to use one.
If you dont own a home, or if you dont have enough equity in your house or apartment to be able to take advantage of a home equity loan, a personal loan could be a better option.
If you need to access a line of credit to make some purchases and you dont expect to take more than a year to pay off your debt, you should consider a credit card with an introductory interest rate offer. Many of the top options let you earn rewards on your spending while enjoying zero interest on purchases or zero interest on balance transfers for 15 months or even longer.
Home equity lines of credit
As mentioned earlier, a HELOC works similarly to a home equity loan in that you borrow cash against the value in your home. But a HELOC acts as a line of credit thats available as you need it, and you only pay back the money you take out.
Refinancing your mortgage
What Is The Minimum Loan Amount For A Home Equity Loan
Whatever you need a large loan for, lenders usually dont make small loans because theyre not as profitable as large loans. The smallest home equity loan available is about $10,000. Some banks have minimum loan amounts of $25,000, and others require borrowing at least $35,000.
A home equity loan is meant for a single major expense. Renovating your kitchen or another big project at home is typical and will require paying a contractor $10,000 or more. Often much, much more.
Home renovations and remodels average $46,822, with most homes falling between $18,410 and $75,947, according to HomeAdvisor. Kitchens are the most expensive costing $25,000 on average for a remodel.
And dont forget budget overages. Unseen problems will probably pop up, so adding 20% to all home renovation budgets is smart.
With all of that in mind, its easy to see how a home renovation can end up costing a large chunk of money. A visit to the emergency room or a college education is also costly, and a HELOC or equity loan can help pay for those big bills.
If you only need $20,000 and the minimum loan amount is $35,000, theres no reason to borrow $15,000 extra. The interest rate on the full amount borrowed takes effect immediately, so youre paying interest on the $35,000 loan whether you use the full amount or not.
But remember that a HELOC only has a lower interest rate than an equity loan for a certain period, such as six to 12 months, so use the credit line before the low interest rate expires.
Home Equity Loans: How To Qualify
The first step in applying for a home equity loan is having enough equity in your home to qualify. Generally speaking, most home equity lenders will only let you borrow up to 85% of your homes value in total between your mortgage and a home equity loan.
For example, if your home is currently worth $400,000, you could owe a total of $340,000 on your mortgage and a home equity loan. So if you already owe $300,000 on your home, you could qualify to cash out another $40,000 with a home equity loan.
Depending on your situation, its likely youll need to have your property appraised to determine how much its worth in todays market. Your home equity lender will usually facilitate this process for you, although an appraisal fee is typically required.
Your is another factor that comes into play if you want to qualify for a home equity loan. While each lender has their own qualification criteria, youll have the best chance at approval if your FICO score is at least good meaning 670 or higher. And youre more likely to get the best rates and terms on a home equity loan if your FICO score is very good, which is generally 740 and higher.
Finally, a home equity lender will consider your debt-to-income ratio, which is how much debt you already have in relation to the income you bring in. Generally speaking, lenders prefer consumers with debt-to-income ratios of 43% or below.
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Calculating A Home Equity Line Of Credit
As per the Office of the Superintendent of Financial Institutions , a HELOC can give you access to no more than 65% of the value of your home. It’s also important to remember that your mortgage loan balance + your HELOC cannot equal more than 80% of your home’s value.
To see how this works, let’s look at an example:
The maximum amount of equity you could pull from your home through a HELOC is $105,000.
Now, you still need to make sure that $105,000 doesn’t exceed 65% of your home’s value. To be sure, simply divide the HELOC amount by the value of your home:
In this example, you could access $105,000 through a HELOC, as it only amounts to 30% of your home’s value.
What Documents Are Needed
Getting a home equity loan is a thorough process. Youll need to pull together the following information and documents:
- Property information .
- Estimated property value.
- Personal information .
- Employment and income information.
- Debts such as auto loans, student loans, credit cards, current mortgage and home equity accounts.
- A completed and signed Internal Revenue Service Form 4506T.
- Copy of your most recent pay stub that reflects earnings for the past month and year to date.
- The most recent two years of W-2 forms from your employer.
- Self-employed borrowers will need the most recent two years of personal IRS tax return documents , the most recent two years K-1s from the partnership, LLC or S Corporation.
- Proof of homeowners, hazard and flood insurance.
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How Much Can Be Borrowed With A Second Mortgage
The amount you can borrow with a second mortgage depends on how much equity you have built up in your property . Various lenders have different restrictions on the loan-to-value ratio they will lend within. Prime lenders in Canada such as Banks, Credit Unions and Mortgage Companies will only allow you to borrow up to 80% of your homes appraised value.
For example, lets say your home is worth $500,000 and you have a current mortgage balance of $350,000, you would only be allowed to borrow an additional $50,000 with a second mortgage.
Appraised value of your home: $500,000
Maximum loan allowed: 80%
Loan amount based on appraised value: $400,000
Minus the balance you owe on your mortgage: $350,000
Second mortgage credit limit: $50,000
For the prime lenders mentioned above, the most common form of a second mortgage is a home equity line of credit . Those are restricted by the 80% restriction in the example. However, there is also another form of second mortgage which will be arranged by what is known as a private lender. A private lender is often the source of a non-HELOC second mortgage and it just refers to getting mortgage funds from a private individual or a group of investors.
Appraised value of your home: $500,000
Maximum loan allowed: 90%
Loan amount based on appraised value: $450,000
Minus the balance you owe on your mortgage: $350,000
Second mortgage credit limit: $100,000
How A Home Equity Like Of Credit Works
Home equity lines of credit are another type of second mortgage that let you borrow cash from your home equity without changing the terms on your first mortgage.
In some ways, HELOCs are more like credit cards than home equity loans. Because you get a credit line you can borrow against, repay, and borrow again. And you pay interest only on your outstanding balance.
And HELOCs differ from HELs in another way.
Home equity loans are installment loans, like a mortgage or auto loan. You borrow a lump sum and pay it back in equal installments over the loans fixed term, usually at a fixed interest rate. So theyre predictable and easy to budget for.
But, with HELOCs, you typically get a loan in two parts.
- During your draw period you pay only interest, usually at a variable interest rate, on your current balance
- Then comes the repayment period, which can often last for half the draw period. During that time, you cant borrow any more but have to zero your debt before that period ends, while keeping up interest payments
HELOCs can be great for people whose incomes fluctuate a lot, such as contractors, freelancers, and those in seasonal jobs. But theyre dangerous for those who are bad money managers. If you tend to max out your credit cards, you may well do the same with a HELOC.
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How Do You Choose The Best Home Equity Loan
Choosing the best home equity loan will require you to do a bit of research. In order to get the best terms and interest rates, be sure to compare different lenders loan programs and fee structures.
Lenders can have different requirements for qualification and offer different terms for home equity loans. If you have a higher DTI or lower credit score, youll find that some lenders are more likely than others to offer you a loan. To ensure that you score the best deal, youll want to shop around to find out what your options are.
When determining which lender to choose, make sure you review the Loan Estimate forms provided by each lender. The Consumer Financial Protection Bureau requires all lenders to provide you with this standard three-page form to ensure that you understand the differences between what lenders are willing to offer you. Loan Estimates will give you a rundown of the terms of your home equity loan, including the interest rate, and itemize the closing costs and fees youll be charged.
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Transfer Your Home Equity Line Of Credit
When your mortgage comes up for renewal, you may consider transferring your mortgage and home equity line of credit. Youll likely have to pay legal, administrative, discharge and registration costs as part of the switch.
You may also be required to pay off all other forms of credit, such as credit cards, that may be included within a home equity line of credit combined with a mortgage.
You may be able to negotiate with a lender to cover some costs to transfer any credit products you may have. This can be difficult if you have different sub-accounts within your home equity line of credit combined with a mortgage that have different maturity dates.
Ask your lender what transfer fees apply.
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