All Things Home Equity Loan

All Things Home Equity Loan
All Things Home Equity Loan

Are you in the middle of a financial crisis? Don’t know what to do with your current assets such as your house? You can take advantage of home equity. First, home equity is the current value of the property less the mortgage balance. You can make the value appreciate over time.

In this article, you will learn what to do with a home loan. Summed up here are the things you should ask yourself and consider in the future. You should also take advantage of these things, so you could maximize your financial resources. Make sure you answer these questions yourself regarding your home equity loan.

  1. Why do I need to borrow funds?

First thing is knowing why do you need to borrow funds- is it really a necessity or are you planning on investing?

Home equity loan can be the answer to your financial crisis, as long as the reason for loaning is valid, then you can use it. However, do not abuse the home equity loan as you might end up losing your home pieces by pieces, literally. Don’t end up living in debt and unpaid home loan.

In order to prevent this from happening, make sure that you keep your loan paid on time, even if there are some uncontrollable and sudden instances like emergency hospitalization and accident. You can best use your home equity loan on these instances aside from home repairs and investment.

If you are planning to have a vacation out of your home equity loan, do not pursue it as you may end up wasting the money. Remember, you are in a financial crisis, so think of something profitable like enhancing your home, building a small business or lending money for profit.

Make a wise decision and evaluate how you are going to pay the loan. Study the interest terms and rates, and make sure that you can produce enough money to pay for the loan.

  1. How much does your home improvement cost?

Some of the amount of your home equity loan should be allocated to home improvement. Your home should be preserved in order to keep the value appreciating. Make a list of the things you need to repair such as water pipes, electricity, roof, and other things. As you maintain your home, the value also increases, but make sure that the money you put on maintenance is all worth it. If your home improvement project’s budget is too huge, then you might end up overspending on maintenance.

  1. Is loan consolidation the best option for you?

Sometimes, people consolidate loans just to pay the other loan. If you are currently paying a high-interest loan, then you might just get tempted about the irresistible low-interest loan home equity loan offers. You may probably think that you can pay the high-interest rate loan with the new loan you have which has lower interest rates. This may sound good, but this could also lead to another nerve-racking problem. If you have another loan, then you might just end up like most people- getting into huge debts due to over spending.

It is hard to pay two loans at a time, and it is even harder if your home is at risk. For sure, you don’t want to end up giving up your home because you can’t pay the loan anymore. So, before making a decision, weigh the pros and cons first, so you won’t regret any move. Consolidated loans may sound good, but it has some consequences too.

  1. How about using the home loan for the student loan?

Just like the recent question, you can pay your high-interest student loan with a low-interest home equity loan but also with some risks involved. According to the CFPB or the Consumer Financial Protection Bureau, another loan can lead to another problem. There is also a big possibility that you cannot repay your home equity loan, so this could lead to foreclosure. You will more likely lose the home and end up with unpaid debts.

According to the CFPB(Consumer Financial Protection Bureau), the federal student loans have a little advantage such as protection in case you have some trouble paying up. In case you use a home equity loan to the federal student loan, that protection will vanish!

You can always ask the office of CFPB if you are in trouble.  They can give you some options to repay your student loan. By doing so, you won’t have to risk your home just to pay off the student loan bills. It is better to go to their office for a consultation.

  1. Is it time to invest for your self-growth?

This may be a good time to use the home equity loan to invest in yourself so that you will have a higher value and self-worth. Once you acquire additional education or training, you will most likely to have a higher income in the future.

However, you can use your home equity loan in other things other than educating yourself. As a matter of fact, the United States Department of Education is able to help to assist you in the financial aspect of your studies, no matter how old you are, what school you are going to and what are you specializing.

  1. What are the types of home equity loans and what is the right type for me?

There are three ways in which banks and other financial institutions are pulling cash out of your home. There might be a lot of choices when it comes to home loan, but these three sum up it all:

Loan Type #1: Home equity loan

This is also known to as junior loan or second mortgage as other people are more comfortable using the two terms. In this loan, the equity of your home is what you will be borrowing or in case you still have mortgage balance, it will be less on the total worth of the home. As per the economy’s current state, due to financial precaution, you can only borrow up to 80 percent of the total value of your home.

Loan Type #2: Cash-out home refinance

This type of loan has a lower interest rate than the first type, which is the home equity loan. The cash-out home refinance is a transaction in which the existing mortgage amount plus the settlement cost is lower than the new mortgage amount. This is a good alternative to the home equity loan.

Loan Type #3: Home equity line of credit (HELOC)

Instead of getting out the lump sum of money from a loan, you will only get or borrow what you need, and your home serves as the collateral no matter how little you borrow. During the draw period, you can borrow anytime and as many times as you want to and at the same time pay back. After this draw period lapses, you can no longer borrow any amount of money and you should pay back what you have borrowed.

The draw period and the repayment period of a loan may differ from other loan programs you might already have before. These two will depend on the loan program. To have a better understanding of this, for example, your draw period is 2 years, so you can borrow money within that period. On the other hand, let’s say your repayment period is 5 years then you need to pay the amount you borrowed in the next 5 years.

Here is the computation of prime rate:

U.S. Prime Rate = (The Fed Funds Target Rate + 3%)

3.25% = (.25% + 3%)

HELOC rate can be prime rate plus the bank’s profit or what we call, the margin. The margin varies depending on the lender’s risk and on your credit score.

This is a sample bank offer:

Bank offering: Prime minus .25% for HELOC

Translation: 3.25% minus .25% equals 3.00%

Therefore, your HELOC rate will be 3.00%

Advantages of HELOC:

Advantage #1: The interest rate is only applied to the amount of money you borrowed and not on the whole loanable amount. For example, you have borrowed only $5,000 out of the $30,000 loanable amount, then you will only pay the interest on the $5,000 you borrowed.

Advantage #2: After paying the amount you borrowed, you will be able to loan it again.

Advantage #3: If your line is left unused, then you will not be required to pay interest.

Advantage #4: Your equity will be instantly accessible to you.

Advantage #5: If you have less than 25% down you will not require to pay PMI.

The Points of Interest of HELOC:

POI #1: Clear things up with your lender, so you won’t jumble the loan terms. The interest only payment has a due and it won’t last forever, so make sure this is clear to you. Typically HELOCs will be due in 25 years, but there are HELOCs than can be shorter than that, so do not overlook this.

POI #2: Be knowledgeable about prepayment penalties. If you close the line immediately, then you will have to pay the prepayment penalty which may run around a hundred dollars. Keep your account open to prevent prepayment penalty. You don’t need to have a maintaining balance in your account.

POI #3: An annual fee is required depending on the bank– usually it is around $50.

Warnings about HELOC according to The Federal Reserve Board:

Warning #1: Watch out for variable interest rates as it may be sugarcoated. You can ask the bank to convert these rates to fixed rates.

Warning #2: You will have other costs such as closing costs, appraisal fees, application fees and other costs that you won’t know in the beginning.

Warning #3: The interest only option can be deceiving. Imagine, if you only pay the interest, then you will have to pay for the whole amount of money that you loan.

  1. How much money you may borrow?

Do not borrow money you don’t need. The loanable amount is up to 80% of your home’s value, so think wisely where you are going to put that huge amount of money. Just borrow what you need, so you won’t end up paying for things that are unnecessary.

  1. Should I sell my assets or should I borrow money?

In your current situation, the decision is up to you, but there are legal things that you have to deal with like taxes. To be sure, you can consult your lawyer about this, or perhaps a tax adviser to be precise.

This is still depending on how much money you need and if you can let go of your assets for good.

  1. Why take advantage of the bigger loan amount?

Lenders will not let you borrow a small amount of money; they go for higher loan amounts. Some banks have a minimum loanable amount such as the Bank of America in which the minimum loanable amount is $25,000. That is the deal with the home equity loan.

That amount of money could be huge and you don’t need it this time, so you can opt for HELOC so you could only borrow what you really need. However, with HELOC, you can’t still borrow a smaller amount because you have to cover the full amount of your home. So, you end up loaning bigger amount of money, but this won’t be a problem as long as you know where to use the money.

10. Did you know that home equity loan or line of credit is the same as a mortgage?

The home equity loan or line of credit is the same as a mortgage, yes, you heard it right! Do not get easily deceived with the bank terms. You should first study carefully the terms before engaging. A mortgage has advantages and disadvantages that you should know of:

Advantages of Mortgage:

Advantage #1: Tax-deductible, this may only apply to some people so better consult with your tax adviser.

Advantage #2: The interest rate is lower than usual and the loan is secured by your home.

Disadvantage of Mortgage:

Disadvantage #1: You home as the collateral is at risk. In case you are not able to pay or fail to pay the loan, then you will more likely lose your home.

11. So, what are the possible solutions to the rising HELOC rates?
Lending can be traumatizing. HELOC, as well as home equity loans, seems to have a lot of drawbacks Paying your HELOC can be very challenging, despite the advantages of it. Can you imagine the distress you might be facing in the future? So, how do we prevent this from happening? What are the possible solutions for this problem?

Solution: Transfer your short-term debt into a long term, into a fixed-rate mortgage. Transfer into a cash-out refinancing of your first mortgage. Why? Here are the reasons that you may find helpful:

Reason #1: Cash-out refinance offer lower payment. The first mortgage will give you a relief because of lower interest rates that you will benefit from rather than the high-interest rate in HELOC. You will also get the chance of reducing your regular payment because your loan payment will be on a long-term basis.

Reason #2: Cash-out refinance is less volatile than HELOC. You don’t need to worry about prime rate increase because you can lock in your rate.

Reason #3: You can now have the ability to pay because you have opted to refinance. You can increase your monthly payment.

Paying your HELOC could be so painful because of the rise in the prime rate, so it is more secure to transfer. Although most financial experts won’t agree on this, it is more secure to do such things than risking the chances of losing your treasured home.

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ratetake

Martin - Head of Real Estate and Finance at RateTake
Martin is Head of Real Estate and Finance division at RateTake. He creates content that helps people understand and make the right decisions for their financial future.
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ratetake

Martin is Head of Real Estate and Finance division at RateTake. He creates content that helps people understand and make the right decisions for their financial future.