One potential asset homeowners have at their disposal is a home equity loan. This is a type of second mortgage that allows the homeowner to borrow against the value of their home.
If borrowers have substantial equity in the home, meaning that the home is worth more than what is owed, owners can access cash through home equity loans to complete projects that are either home or non home-related. They can also be used to consolidate debt. Further, rates are typically lower than unsecured rates and allow for large-sum loans.
Once a loan is approved, a lender will pay out in one lump sum. Another possibility is to establish a home equity line of credit or (HELOC). This acts as a line of credit that is available for a set period of years, in which time the homeowners can draw money as needed, instead of one lump sum.
Home equity loans are attractive for many reasons. Obviously, the most attractive is that homeowners potentially have access to large sums of cash.
The qualification process may be simpler than typical or unsecured loans, since the loan is secured by the value of the home. Along with interest rates, terms and monthly payments can be fixed. Like any other loan, lending institutions typically want to see property information and monthly financial information before making a loan determination.
Interest rates are lower with home equity loans. This makes these loans popular with those looking to use their home’s cash to consolidate credit card debt.
A home equity loan is possible if there is substantial equity built into the property. Equity can be estimated by subtracting what is owed from the market value of the home.
Reducing debt is a good way to build equity. At the beginning of most loans, typical amortization will mean most of the monthly mortgage payment will go towards interest. As the loan ages, most of the payments will then shift towards principal, thus building equity year after year.
Another way to build equity depends on a healthy market. Equity will increase with the market value of the property.
Like any other loan, a home equity loan comes with certain risks. The biggest risk is that the collateral is tied to the house and could be foreclosed on should the borrowers neglect their repayments.
Since the equity can provide cash quickly, a potential exists of accumulating more consumer debt, especially if the lump sum is used to pay down credit cards or used for unnecessary items. Best practice is for any money to be spent towards the value of the home. Borrowers would be smart to consider how best to use the lump sum responsibly and not borrow more than they need.
When considering tax write-off, borrowers should understand that new tax rules specify home equity interest can now only be deducted on projects dedicated exclusively to home improvement.
Borrowers should have a good understanding of potential costs, minimum withdrawal requirements, and fees that are required when securing a home equity loan. For example, closing costs alone can reach into the thousands.
Markets are not perfect and fluctuations can include down-turns. Crashes can cause the borrower to become upside down in a loan, thereby owing more than the home is worth.
It’s important to remember that these are safer loans from the lender’s perspective, as they’re secured with the borrower’s property as collateral. Therefore, any potential user should have a clear understanding of their own financial blue print and how any money would be used.