June 23rd, 2019 9:23 AM by Jackie A. Graves, President
The pros and
cons of home equity loans, including a home equity line of credit or HELOC, home equity loan
and cash-out refinance, can be confusing to some borrowers.
which type of equity loan is best for you depends on several factors:
How much equity you have.
How much you want to borrow.
When you plan to repay the money.
Whether you want a fixed or flexible term.
The interest rate on your current mortgage.
equity line of credit
A HELOC is a
credit line secured by your home. Most HELOCs have an adjustable rate,
interest-only payments for a specified time, and a 10-year “draw” period,
during which the borrower can access the funds.
After the draw
period ends, the outstanding balance must be repaid, typically over a 15-year
with adequate income who don’t tip the debt overload scale can qualify for this
type of loan. They can find this type of financing for 80 percent of combined
loan to value or even 85 percent or 90 percent combined loan to value.
Lenders calculate the
combined loan to value by adding all mortgage debt and dividing the total by
the home’s current appraised value.
Formula: (Amount owed on primary mortgage + second mortgage) /
Example: Morgan owes $60,000 on the primary mortgage and has a
HELOC for up to $15,000. The house is worth $100,000. The CLTV is 75%: ($60,000
+ $15,000) / $100,000 = 0.75
pros and cons of a HELOC
a first mortgage, a HELOC can be a good way to borrow a small
sum for a short time, says Justin Lopatin, vice president of residential
lending at PERL Mortgage in Chicago. For example, you might borrow $20,000 that
you plan to repay within three to five years.
One bad thing
about a HELOC is it can be “very tempting” to access it, even if it’s not necessary,
says Alan Moore, CEO of AdvicePay, a payment-processing platform for financial
“You have to
carefully consider: What are your long-term goals? What is the money for?”
Moore says. “Realistically, having easy access to money is not always a good
equity loans are less common
A home equity
loan, like a first mortgage, allows you to borrow a specific sum for a set term
often at a fixed rate. That’s why these loans are sometimes called second
loans aren’t as common, but many banks offer them, and they do have the
advantage of a fixed rate and payments.
equity loans with fixed rates and terms
alternative is a HELOC that’s structured like a fixed-rate home equity loan.
senior vice president of home equity for Wells Fargo in San
Francisco, says the bank offers a HELOC with a fully amortizing payment, which
means the loan is repaid in full if all the payments are made through the draw
payment you make, you pay down a little bit of principal and a little bit of
interest. So, when you get to the end of your draw period, you don’t have a big
payment shock,” Kockos says.
A fixed-rate advance option allows the
borrower to lock in a portion of the credit line at a fixed rate and term. If
interest rates change, the advance can be unlocked to float down to a lower
rate, Kockos says.
only one mortgage? Go with a cash-out refi
refinance is an entirely new first mortgage with cash back when the loan
appeals to homeowners who want to refinance and take out cash at the same time.
“It’s a good
way to grab equity and keep it all in one loan,” Moore says.
however, that any loan or cash-out strategy must have a clear purpose. Don’t
take the cash just because you can.
typically limit the cash-out refinance to 80 percent of the home’s value, says
Jay Voorhees, broker and founder of JVM Lending, a mortgage company in Walnut
fees and interest rates
important to compare closing costs and home equity
loan rates. Fees might be higher for a cash-out refinance than for a
HELOC, but the interest rate might be lower for a cash-out refinance.
to lock in a low fixed rate is an advantage of a cash-out refinance, Voorhees
says. “Whenever your payback period is going to be relatively slow, it behooves
you to have a fixed rate because it’s much safer,” he says.
current interest rate matters
monthly payment might be higher or lower than your current payment, depending
on your interest rates, loan balances and repayment terms.
if your existing mortgage has a very low rate and you go for a cash-out refi,
you could end up paying a higher rate on your entire loan, not just the
bought (your home) in 2012 or 2013 and got a rate in the 3s, you may not want
to touch that because it’s such a pristine loan that can’t be beat,” Lopatin
says. “If you purchased (before then) and maybe haven’t refinanced, it may make
sense to roll everything into one loan.”
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