All You Need to Know About Home Equity Loans

Home Equity LoansAs you pay down your first mortgage or the value of your home increases, you develop equity. When you have equity built up in your home, borrowing against it with a home equity loan is a great way to tap into the money when you need it most. Many people take out a home equity loan to finance home improvements, pay for their child’s college education, cover unforeseen medical costs, and many other purposes. Here’s all you need to know about home equity loans.

What is a home equity loan? 

A home equity loan (HEL), or second mortgage, is a secured loan that allows homeowners to borrow against the equity in their home. The loan amount is based on the difference between the home’s current market value and the homeowner’s outstanding mortgage balance. Home equity loans tend to be fixed-rate, while the typical alternative, home equity lines of credit (HELOCs), generally have variable rates and allow the borrower to withdraw funds as needed.

How is a home equity loan amount determined?  

Your primary mortgage is the amount you borrowed when you first purchased your home. Over time, as you pay down the loan and/or the value of your residence increases, so does your equity. You can take a home equity loan out against the equity you have built up in your home, essentially borrowing against your home’s value minus what you still owe on your mortgage. It’s important to note that a home equity loan is a second loan against your home. You’ll still need to pay your primary mortgage along with new payments for your home equity loan.

A lender will typically want you to have at least an 80 percent loan-to-value (LTV) ratio once your home equity loan has been approved.

Interest rates on home equity loans 

Home equity loans typically have a fixed interest rate, making budgeting for the payments easy. The lender provides a lump sum payment to the borrower, which is then repaid over the life of the loan, along with a set interest rate. Both the monthly payment and interest rate will remain the same over the entire loan term, which can last anywhere from 5 to 30 years. If the borrower sells the home before the loan term is matured, the loan must then be repaid in full.

A home equity loan can be a great choice for a borrower with a one-time or straightforward cash need such as a home addition, large medical expenses, debt consolidation, or a wedding.

Are there any costs associated with home equity loans?

As with mortgage loans, there are closing costs associated with home equity loans. Closing costs refer to any fees incurred when originating, writing, closing, or recording a loan. These fees include application, appraisal, title search, attorney fees, and points. Some lenders may advertise no-fee home equity loans which require no cash at closing, but these will usually have other associated costs or a higher interest rate which can easily offset any gains.

What are the pros and cons of a home equity loan?

There are several advantages to taking out a home equity loan to fund a home improvement project or a large expense:

  • The amount of interest paid toward a home equity loan may be tax-deductible.
  • Interest rates on HELs are generally lower than those provided by credit cards or unsecured loans.

Home equity loans do have some disadvantages as well:

  • Using your home as collateral for the loan means risking foreclosure and the loss of your home if you default on the loan.
  • If your home value declines over the term of the loan, you may end up owing more than your home is worth.
  • You’ll need to pay closing costs and other fees when you take out a home equity loan.
  • You may qualify to borrow more than you actually need and ultimately end up using more than planned, which of course you’ll need to repay.

The hot real estate market has led to a boom in popularity for home equity loans. However, it’s important to weigh all factors carefully before determining if a home equity loan is best for your specific needs.

Freedom has Home Equity Loans and Home Equity Lines of Credit available.  Visit freedomfcu.org/personal/home-loans/ for more details. 

Your Turn: Do you have questions or advice about home equity loans?  Talk to us on Facebook, LinkedIn,Twitter, or Instagram @FreedomFedCU.

 

IS NOW A GOOD TIME TO OPEN A HELOC?

Is a HELOC a good idea

If you’re looking to fund a home improvement project, or if the economic devastation of COVID-19 has left you in need of cash, consider tapping into your home’s equity with a home equity line of credit, or ‘HELOC’.

What is a HELOC?

A HELOC is a revolving credit line allowing homeowners to borrow money against the equity of their home. Borrowers can withdraw money as needed during a set amount of time known as the “draw period,” which generally lasts 10 years. Some lenders place restrictions on HELOCs and require borrowers to withdraw a minimum amount of money each time they make a withdrawal, regardless of need. Other restrictions include the requirements to keep a fixed amount of money outstanding or to withdraw a specific sum when the HELOC is first established; however, borrowers are typically free to spend the money however they please.

Most homeowners are eligible for a HELOC with a debt-to-income ratio that is 40% or less, a credit score of 620 or higher and a home assessment that stands at a minimum of 15% more than what is owed.

How do I repay my HELOC?

Repayment of HELOCs varies but is generally flexible.

Many lenders collect interest-only payments during the draw period, with principal payments being strictly optional. Others require ongoing monthly payment toward both principal and interest.

When the draw period ends, some lenders require borrowers to pay back the entire loan “balloon” amount. Others allow borrowers to pay back the loan in monthly installments over a new time period, known as the “repayment period.” Repayment periods are generous, lasting as long as 20 years.

What are the disadvantages of a HELOC?

A HELOC places your home at risk of foreclosure if not repaid. Before opening a HELOC, it’s a good idea to run the numbers to ensure you can easily meet the payments.

Also, many lenders require the full payment of the HELOC after the draw period is over. This can prove to be challenging for many borrowers.

Finally, if you don’t plan to stay in your home for long, a HELOC may not be the right choice for you. When you sell your home, you’ll need to pay the full balance of the HELOC.

A HELOC can be a great option now

HELOCs have variable interest rates, which means the interest on the loan fluctuates along with the general interest rate, sometimes dramatically.

The economic fallout of COVID-19 has generated historically low interest rates. The average APR for fixed 30-year mortgages has hovered at the low 3% for months now, and experts predict it will continue falling. The low rates make it an excellent time to take out a HELOC with manageable payback terms.

The economic uncertainty the pandemic has generated also makes it a prime time to have extra cash available for any need that may arise.

Now may be the perfect time for you to refinance your current mortgage, from another loan provider, into a lower rate from Freedom Federal Credit Union! We offer a wide range of programs with low rates and great terms. Contact us about a refinance option that meet your needs today.

About Freedom Federal Credit Union

Freedom serves and is open to anyone who lives, works, worships, attends school, volunteers, or has family in Harford or Baltimore County, MD. As a credit union, we are committed to putting you first, not shareholders, and helping you achieve your financial goals. Learn more at freedomfcu.org or call us 800-440-4120 to see how we can help.

Your Turn: Are you looking to sell your home? Tell us about it on Facebook, Twitter, or Instagram. @FreedomFedCU