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Home Equity Loans: What questions should you ask before applying?
If your home’s current market is worth more than the total amount of your remaining mortgage payments, then you’ve built up equity in your home. Many people who have equity in their homes are able to apply for home equity loans and use that portion of equity–or ownership–as collateral for the loan.
Remember when home mortgages were upside-down? Home values are making a comeback after the Great Recession and borrowers are taking advantage of the opportunity to withdraw cash for major expenses or improvements. If you’re in the market for a home equity loan, here are some things you’ll want to consider before you sign on the dotted line:
Do you have enough equity in your home?
Your combined loan-to-value ratio (CLTV) plays a critical role in the approval of an equity loan. Your CLTV ratio is the calculation of your current loan balance plus the additional equity loan amount divided by the appraised value of your home. Generally, lenders require your CLTV to be 85% or less.
What type of home equity loan do you need?
Home Equity Loan
The traditional home equity loan offers the borrower a single lump sum to be repaid over a specific period of time, up to 30 years, at a fixed interest rate. Home equity loans are generally used for large expenses, like replacing a roof or paying off credit card debt, and are ideal for borrowers who need cash for a one-time event. It’s often referred to as a second mortgage, complete with closing costs and notarized signatures.
Home Equity Line of Credit
A home equity line of credit (HELOC) is another type of home equity loan where the lender approves smaller sums of cash up to a fixed amount, similar to a credit card. Its flexibility allows the borrower to withdraw cash as needed and pay interest only on the amount that is withdrawn. Although repayment doesn’t begin until a predetermined date in the future, there is often an annual fee. HELOCs are ruled by adjustable interest rates, but they can be converted to a fixed rate loan once the repayment period begins.
HELOCs are ideal for borrowers who need frequent access to cash to pay contractors during a remodel or even a recurring quarterly tuition bill. They also offer the benefit of not having to pay interest on the loan amount until it’s actually withdrawn.
A mortgage is a mortgage
Regardless of the outstanding amount, the term, or the interest rate, a home equity loan or a HELOC is still a second mortgage. Just as in your first mortgage, the interest you pay is usually tax-deductible, to a certain limit, and rates are generally lower than you’d be charged on a credit card.
You shouldn’t forget, however, that the second loan is secured by your home, which subjects your property to additional risk. You can be foreclosed upon if you’re unable to make your monthly mortgage payments. Be sure to treat your home equity loan or HELOC with just as much importance and seriousness as your first mortgage.
Applying for a second mortgage could be a wise financial decision and a step forward in helping to organize your finances. Consider all of your options and consult with a financial advisor to see if a home equity loan might be a good fit for managing some of your larger expenses.