Often, the monthly mortgage payment is one of a homeowner’s greatest expenses. At the same time, the home itself can be one of their greatest assets. As you build equity in your home, you may be wondering how to tap into that wealth-building potential. If you’re looking to have the ins and outs of a home equity loan explained, you’ve come to the right place.
Capital Credit Union helps homeowners just like you who are looking to leverage their home’s value to access additional funds. We’ll explain what you need to know before applying for a home equity loan and help you decide which type of equity loan may work best for you.
Basics of Home Equity LoansA home equity loan functions as a second mortgage where you borrow an additional amount against the equity that has built up in your home. The amount of home equity you have can be determined by subtracting any liens you have against the home from the property’s appraised value. Typically, lenders will finance loans of up to 80 to 85 percent of a home’s value, minus the current mortgage, although other factors will play a part in the lender’s decision.
For instance, if you have an existing mortgage on your home, your loan-to-value (LTV) ratio will take into account both your outstanding balance on your first mortgage and the amount of the home equity loan for which you’ve applied. The lower your LTV, the lower your interest rate is likely to be. To determine your eligibility and interest rates, the lender will also likely consider your credit history and your debt-to-income ratio, just as when you applied for your original mortgage.
Because you’re using your home as collateral for your home equity loan, you must pay it off if you plan to sell your home. If your home equity loan is open at the time of the home sale, you can pay the outstanding balance through sale proceeds.
Risks vs. RewardsAs with any financial decision, you must also weigh both the risks and the rewards of borrowing against your home. While homes may go up in value, they can also lose value over time. This is sometimes based on factors outside your control, such as market conditions at the time you buy and sell your home.
On the other hand, a home equity loan could help you consolidate debt, make home improvements, and save money in the long run. Be sure to carefully consider both the advantages and disadvantages of taking out a home equity loan before deciding to close on one.
Home Equity Loan Options
There are two main types of home equity loans: conventional home equity loans and revolving home equity lines of credit (HELOCs). Each type of equity loan operates a little differently:
Home Equity LoanA home equity loan is similar to a traditional mortgage. You select your term (how much time you have to pay back the loan) and the amount you wish to borrow.
If you opt for a fixed-rate home equity loan, your monthly mortgage payment will also be a fixed amount, calculated based on principal, interest rate, and the number of loan payments you will make over the loan term. At Capital CU, we offer offer 5-, 7-, and 10-year terms for fixed-rate home equity loans.
With an adjustable-rate home equity loan, on the other hand, the interest rate fluctuates (or adjusts) throughout the life of the loan, based on market conditions. If market conditions are favorable, your interest rate will be lower. If the market is more volatile, your rate will likely be higher. Typically, however, there is a maximum cap on how high the interest rate can climb. We offer three- and five-year terms for adjustable-rate home equity loans.
Home Equity Line of CreditA HELOC operates similarly to a credit card but without the high interest rate that typically accompanies a credit card. Qualify for a competitive interest rate while benefiting from more flexibility than a traditional home equity loan.
HELOCs operate as a revolving line of credit with what’s known as a draw period. During the draw period, you can borrow as much or as little of the approved amount as you need and will only be responsible for paying monthly interest on the amount you’ve borrowed, rather than principal plus interest. Most HELOCs, including those offered by Capital CU, come with a draw period lasting up to 10 years.
If you decide to pay back all or a portion of the amount you borrowed during the draw period, you can draw against the approved amount again. In fact, you can borrow against it, pay it back, and borrow again as many times as you wish during the draw period. Once the draw period is over, however, you will no longer be able to borrow against the line of credit. Instead, you will be required to repay the principal plus interest on the borrowed amount.
Which Home Equity Loan Option Is Right for Me?
Determining which home equity loan is right for you depends on a number of factors, including your personal financial situation, risk tolerance, and desired repayment strategy.
For instance, if you’re uncertain exactly how much money you’ll need in total, you probably want to have access to everything you might need while only paying interest on the amount you actually use. In this case, a HELOC may be the best loan option.
On the other hand, if you know exactly how much you want to borrow and prefer the predictability of a fixed payment, a fixed-rate home equity loan may be the best option for you. Similarly, if you know exactly how much you want to borrow but have a higher risk tolerance or would prefer a lower interest rate to start with, you may prefer to opt for a home equity loan with an adjustable interest rate.
Perhaps you expect to come into some money in the future and just need the extra funds to hold you over. If so, you may benefit from the interest-only payments a HELOC provides during the draw period.
Talk to your lender about your unique financial situation and needs. Once you’ve had your home equity loan options explained, a home loan expert can help you determine which will serve you best.
The team at Capital Credit Union is here to help you secure a promising financial future by guiding you through the next steps of your financial journey. Get started today.