A home equity line of credit (HELOC) is a great source of cash that comes with a low interest rate and tax benefits. In a HELOC, lenders will allow up to 85% of the approved value of the home and subtract the amount you currently owe on your previous mortgage. A home equity line of credit is a loan that has a lien on your property. If you are selling your home, you must pay off this loan first.
Due to the additional costs involved in approving a HELOC, it is considered to be a traditional mortgage loan. So, it is worth applying for a HELOC only if you can make good use of the loan. Before applying for a HELOC, clarify payment options, penalties for late payment, default conditions, and so forth. Also, ask your lender whether there is a minimum and maximum limit to the amount that can be withdrawn at a time and the rules to access to the credit. There are normally several interest options for a home equity line of credit. Ask your lender to clarify them. If your HELOC comes with a variable interest rate, check the periodic cap and lifetime cap limit. Also check for the index and margin. It is also important to know whether you can change a variable rate loan to a fixed rate in the future.
Both a HELOC and home equity loan (HEL) are secured by a lien on your property, and both are calculated by the percentage of the property value and subtracting the existing owed amount from it. However, the fundamental difference between them is that a home equity loan is obtained as a lump sum whereas a HELOC can be utilized at the borrower’s convenience.
A home equity line of credit is suitable for remodeling a house, covering medical expenses, tuition fees and other short term major costs. The nature of the loan gives the flexibility that is required to meet periodic and short term regular expenses as well as sudden unexpected bills. Whenever the borrower needs the money, they can have access to any amount within a set limit approved by the bank.
Rising consequences of falling property prices have tightened the standard for home equity loans. In spite of this, home equity loans are available at suitable rates and conditions. However, lenders normally limit the loan to below 70% of the equity of the home. Now, the borrowers have to have significant equity in their home in order to qualify for the loan.
It is also possible to take out a home equity loan out of bad credit, which is called a bad credit home equity loan. In this case, particular rules apply which include high interest rates and other unfavorable terms. Lenders will identify what percentage loan they will approve against your home equity. In this situation, you should give it serious consideration, and get more than one opinion, before taking out a home equity loan under those conditions.
Deciding on a Home Equity Credit Line
If you need to take out a loan, a home equity credit line can be a great source of funding. Home equity loans can provide large amounts of money at lower interest rates, and tax breaks as well. A home equity line of credit (HELOC) allows you the flexibility to choose how you receive your money and use it when you need it.
The amount of equity credit is typically calculated by taking a percentage of the home’s appraised value and subtracting from that the balance owed on the existing mortgage. For example:
Appraised value of home = $200,000
Percentage = 75%
Percentage of Appraisal = $150,000
Minus the balance owed = $50,000
Potential line of credit = $100,000
Depending on your credit, home equity lenders may let you borrow up to 85% of the appraised value of your home minus the amount you still owe on your first mortgage. However, home equity credit lines require you to use your home as collateral for the loan. This means that your home can be lost if you cannot make your monthly payments. Also, if you sell your home, most plans require you to pay off your credit line at that time. Contact your lender to compare options and select the home equity credit line that best fits your needs.
Questions to Ask Before Opening a Home Equity Line of Credit
A home equity line of credit can come with many of the same expenses that financing your original mortgage had. These expenses can add considerably to the cost of your loan, so make sure it’s worth it if you only need to borrow small amounts from your credit line. There are many questions you should know the answers to before signing on the dotted line. Here are some of the major topics to discuss with your lender about a home equity line of credit.
● Find out how often and how much your payments can change.
● Ask if you are paying back both principal and interest, or interest only.
● Ask whether your monthly payments will cover the full amount borrowed or whether you will owe an additional payment of principal at the end of the loan.
● Ask about penalties for late payments and under what conditions the lender can consider you in default and demand immediate full payment.
● Ask the lender about the length of the home equity loan, whether there is a minimum withdrawal requirement when you open your account, and whether there are minimum or maximum withdrawal requirements after your account is opened.
○ Inquire how you access your credit line.
○ Find out if your home equity plan sets a fixed period when you can make withdrawals from your account.
○ Ask about the type of interest rates available for the home equity plan. Most home equity credit lines have variable interest rates.
○ Check and compare the terms of a variable rate.
○ Check the periodic cap, which is the limit on interest rate changes at one time.
○ Also, check the lifetime cap, which is the limit on interest rate changes throughout the loan term.
○ Ask the lender which index is used and how much and how often it can change. An index is used by lenders to determine how much to raise or lower interest rates.
○ Check the margin, which is an amount added to the index that determines the interest you are charged.
○ Ask if you can convert your variable rate loan to a fixed rate at some future time.
○ Ask if you might owe a large payment at the end of your loan term.
○ Ask about the conditions for renewal of the plan or for refinancing the unpaid balance.
Choosing a Home Equity Loan or Home Equity Line of Credit
Home equity loans can be obtained in a lump sum or used as a home equity line of credit. Not all plans are right for everyone, so comparing your options is a good idea.
A home equity loan refers to a single loan taken out and secured by the equity you have in your home. The money is paid in one lump sum and you pay it off over a fixed number of years.
A home equity line of credit is secured by your property also, but with a key difference. When you set up a home equity line of credit, the bank lends you a certain amount, but you take out the funds when you need them. Thus, you are able to borrow up to your credit limit as you need, and pay it back over time.
With both loans, your equity is calculated by taking the market value of your home and subtracting the balance owed. For example:
Appraised value of home = $200,000
Minus the balance owed = $50,000
Home equity = $150,000
Home Equity Line of Credit: Flexible and Convenient
A home equity line of credit has an adjustable interest rate and works more like a credit card that has a revolving balance. The nice thing about a home equity line of credit is that it provides flexibility. Instead of borrowing one big lump sum all at once, the home equity line of credit allows you to borrow smaller sums as you need them over time and pay them back. Therefore, you only pay interest on whatever you borrowed.
Important Home Equity Terms and Definitions
Understanding some common home equity terms and definitions can help you through the process.
Equity
Equity is the difference between the home’s fair market value and the unpaid balance of the mortgage and any outstanding liens. Equity increases as the mortgage is paid down or as the property value appreciates.
Collateral
In a home loan, the property is used to secure the loan. The lender can take the property if the loan is not repaid according to the terms of the mortgage or deed of trust.
Appraised value
An opinion of a property’s fair market value, based on an appraiser’s knowledge, experience, and analysis of the property.
Credit
An agreement in which a borrower receives something of value in exchange for a promise to repay the lender at a later date.
Home equity loan
A loan secured by equity in a primary home or second home. The loan has a fixed interest rate and is received as a lump sum, designed to be paid off over a set amount of time with the same payments each month.
Home equity line of credit
Differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit. A home equity line of credit has an adjustable interest rate and works more like a credit card that has a revolving balance.
Fixed-rate mortgage
A home loan in which the interest rate does not change during the entire term of the loan.
Adjustable Rate Mortgage (ARM)
A home loan where the interest rate can go up or down at certain periods stated in the loan document during the time you are repaying the loan.
Reverse Mortgage
A home loan that gives cash advances to a homeowner, requires no repayment until a future time, and is capped by the value of the home when the loan is repaid.
Cash-out refinance
When a borrower refinances his mortgage at a higher amount than the current loan balance with the intention of pulling out money for personal use.
Annual Percentage Rate (APR)
The cost of a loan given as a percentage rate. It includes both the interest rate on the loan and many of the costs in getting the loan.
Balloon Payment
This is the large payment that is due at the end of some mortgage loans. A balloon payment means that the borrower’s monthly payments are used mainly to pay the interest on the loan and that little of the payment is used to pay back the principal.
Principal
The amount of money that you borrow.
Interest
The percentage rate lenders charge you for using their money.
Line of Credit
A pre-approved amount that you can borrow. You only borrow what you need, when you need it.
Closing costs
Expenses incurred by buyers and sellers in transferring ownership of a property.
Home equity line of credit
A home equity line of credit is a good option when you need money to remodel your house, or for periodic medical treatments that are not covered by insurance. Unlike a home equity loan, a home equity line of credit gives you the flexibility to borrow what you need, when you need it.
Home equity loans are available as a fixed rate loan or an adjustable rate line of credit. A home equity line of credit is ideal if you need access to money periodically and not all at once. These loans carry lower interest rates than unsecured personal loans and can be used for many things, such as debt consolidation, home improvements, tuition, medical bills, and large expenses.
Tightening Standards for Home Equity Loan
Falling property values have tightened the standards for homeowners wanting to secure home equity loans. However, home equity loans are still being approved, just at much lower rates.
Lenders have become more cautious over the past year, particularly for home equity loans. Typically, lenders will not authorize any loans that go above 70 percent of your home equity. Thus, you will need significant equity in your home if you want to qualify. If you can meet these standards, it’s still possible to get a home equity loan to finance major expenses.
Home Equity Loan with Bad Credit
When you have a poor credit history, a bad credit home equity loan can help you access the equity in your home. However, there are different rules that will apply which you should consider before taking out a loan.
Expect high interest rates
Be prepared to pay higher rates since you will be considered higher risk.
Unfavorable terms
You may only qualify for adjustable rate terms in order to be able to afford the monthly payments.
While a bad credit home equity loan may have its downsides, you are able to utilize your home’s equity as you need.
Qualifying for a home equity loan
In order to qualify for a home equity loan, the lender will check your credit and income. However, the main factor in determining your qualifications is by calculating your home’s current market value minus the debt you still owe. For example:
Appraised value of home = $100,000
Minus the balance owed = $50,000
Home equity = $50,000
The lender will determine based on other factors what percentage of the $50,000 they are willing to lend you.
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