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Home News Home Equity Loans: A Beginner’s Guide
November 14, 2024
Owning a home is more than just having a place to live—it’s a valuable financial asset. Over time, as you pay off your mortgage and property values rise, you build what’s known as “equity.” This equity represents the portion of your home that you truly own and can be leveraged to secure financing for various needs. A home equity loan allows you to tap into that hard-earned value, providing access to funds that can help you achieve larger financial goals. Whether you’re considering home improvements, paying off debt, or covering unexpected expenses, understanding how a home equity loan works can help you unlock your home’s potential while keeping your financial future on track.
A home equity loan allows you to borrow money using the equity you’ve built up in your home as collateral. The equity in your home is the difference between what your home is currently worth and what you still owe on your mortgage. Lenders typically allow you to borrow a portion of this equity, which you receive as a lump sum. Because your home secures the loan, it usually comes with a lower interest rate than unsecured loans, such as credit cards or personal loans.
To give you a better understanding, let’s break it down with an example:
Imagine you own a home valued at $300,000 and still owe $150,000 on your mortgage. The difference between the home’s value and what you owe is your equity, which in this case is $150,000.
Most lenders won’t allow you to borrow the full amount of your home’s equity. Instead, they typically allow you to borrow anywhere from 70-85% of the equity you’ve built. This is known as the loan-to-value ratio (LTV), which represents the percentage of your home’s current value you can borrow.
In this example, 80% of your home’s value would be $240,000.
$300,000 x .80 = $240,000
Since you still owe $150,000, your available equity for borrowing is the difference between $240,000 and $150,000, which equals $90,000.
This means you may be able to borrow up to $90,000 with a home equity loan, depending on the lender’s terms and your financial profile (such as your credit score and income).
A home equity line of credit (HELOC) is another way to borrow against the equity in your home, but it works more like a credit card than a traditional loan. Instead of receiving a lump sum of money upfront, as you would with a home equity loan, a HELOC allows you to draw funds as needed up to a certain limit during a designated draw period.
While both home equity loans and HELOCs allow you to borrow against the value of your home, they differ in several ways. One key difference between a HELOC and a home equity loan is that the interest rate on a HELOC is often variable, meaning it can fluctuate over time. Also, you’re only required to make payments on the amount of credit you use, not the entire credit line, making this option more flexible for ongoing projects or expenses. Here are some other critical differences to keep in mind:
Payout Structure: A home equity loan gives you a lump sum of money upfront, whereas a HELOC provides access to a revolving line of credit.
Interest Rates: Home equity loans typically have fixed interest rates, while HELOCs often come with variable rates that can change over time.
Repayment: With a home equity loan, you start repaying the principal and interest immediately. In contrast, HELOCs may allow for interest-only payments during the draw period, with full repayment required afterward.
Purpose: A home equity loan is ideal for one-time expenses like major home improvements, while a HELOC is better suited for ongoing expenses or projects.
The interest rate on a home equity loan is generally lower than the rates on unsecured personal loans or credit cards because it’s a secured loan backed by the value of your home. The exact rate you qualify for depends on several factors, including your credit score, the loan-to-value ratio (LTV) of your home, and current market interest rates. Home equity loans are usually indexed to the prime rate, which is the industry base rate. The prime rate represents the lowest credit rate available for highly-qualified borrowers; however, most lenders will add a margin to the final rate. For instance, lenders that apply a 1.50% margin to a prime rate of 8% would offer a borrower a home equity loan rate of 9.50%.
One of the advantages of a home equity loan is its fixed interest rate. This means that your rate will remain the same for the entire term of the loan, offering protection against rate increases in the future. As a result, your monthly payments will be predictable, making it easier to budget and plan.
Also known as “secondary liens” or “second mortgages,” home equity loans finance a portion of your home’s total value. After determining the amount of equity in your home, lenders typically allow you to borrow a percentage of that equity. The exact amount depends on the lender’s policies and your financial situation but is usually capped at around 85% of your home’s equity. There are some lenders who may allow you to borrow 100%.
Once approved, you receive the loan as a lump sum of cash at closing, which you’ll repay over a set period (often 5 to 30 years) through regular monthly payments. The loan is secured by your home, meaning that if you default, the lender can foreclose on your property to recover their losses. This added security enables lenders to offer competitive interest rates and terms. Your home equity loan’s fixed rate does not conflict with your primary mortgage rate; however, it’s important to consider the affordability of paying your primary and secondary mortgages together each month. Borrowers interested in a home equity loan should have a good understanding of the cost of their project. Based on your home’s value, you can calculate the value of your equity to determine if you have enough to cover the expenses adequately. First Hope Bank has a variety of loan calculators to help ensure your loan suits your needs.
Home equity loans can be used for a variety of purposes, such as:
Home Improvements: Renovating your home can increase its market value, making it a smart use of a home equity loan.
Debt Consolidation: If you have high-interest debt, such as credit card balances, you can use a home equity loan to consolidate those debts into a single, lower-interest payment.
Education Costs: Paying for a child’s college education or furthering your own studies are common uses of home equity loans.
Major Purchases: Whether a new car or a once-in-a-lifetime vacation, a home equity loan can help cover substantial costs.
Medical Bills: Unexpected medical expenses can be overwhelming, but using your home equity can ease the financial burden.
When considering a home equity loan, it’s best to leverage your home’s equity to build wealth. For instance, vacations are purchases that cannot be recouped.
To qualify for a home equity loan, you’ll need to meet certain requirements. While the exact criteria may vary depending on the lender, most will consider the following:
For interested borrowers living in New Jersey or Pennsylvania counties of Berks, Bucks, Carbon, Lehigh, Monroe, Montgomery, Northampton, Pike or Schuylkill, First Hope Bank offers a comprehensive home equity loan checklist for your convenience.
Fixed Interest Rates: Home equity loans typically have fixed interest rates, which provide predictability and stability in monthly payments.
Lower Interest Rates: As a secured loan, home equity loans often have lower interest rates than unsecured loans or credit cards.
Lump Sum Payment: Ideal for large, one-time expenses
Tax Deductible Interest: In some cases, the interest on a home equity loan may be tax-deductible if the funds are used for home improvements.
Risk of Foreclosure: Since your home is the collateral, failure to repay the loan could lead to foreclosure.
Closing Costs: Similar to your original mortgage, home equity loans often come with closing costs, which can include appraisal fees, origination fees, and more.
Fixed Payment Schedule: While predictable, the fixed monthly payments may not offer the flexibility some borrowers need, especially if their financial situation changes.
When considering a home equity loan, it’s important to weigh it against other financial options. Here are some common alternatives:
Pros: Quick access to funds, no need for collateral
Cons: Higher interest rates, risk of accumulating debt over time
Pros: No need to use your home as collateral, quicker approval process
Cons: Higher interest rates, lower borrowing limits compared to home equity loans
Pros: Potential for a lower interest rate if you refinance your entire mortgage
Cons: Extends your mortgage term, closing costs can be high
Pros: Flexibility to borrow only what you need, typically lower payments during the draw period
Cons: Variable interest rates can lead to unpredictability in monthly payments
If you’re ready to unlock the potential of your home’s equity, First Hope Bank is here to support your home equity fixed loan needs. We understand and appreciate just how valuable your home can be and can help you make the most of all your house has to offer. With fixed interest rates and predictable monthly or bi-weekly payments, a home equity loan provides the stability and security you need to manage your finances with confidence. First Hope Bank offers competitive rates and personalized service, ensuring your loan fits your needs and goals. Whether you’re planning a home renovation or consolidating debt, First Hope Bank is here to help.
Take the next step today—schedule an appointment for a home equity loan consultation with a First Hope Bank loan officer to discuss how a home equity loan can work for you!
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