August 4th, 2019 9:54 AM by Jackie A. Graves
One of the biggest perks of home ownership is the ability to
build equity over time. You can use that equity to secure low-cost funds in the
form of a “second mortgage” – either a one-time loan or a home equity line of
There are advantages and disadvantages to each of these forms of credit, so
it’s important to understand the pros and cons of each before proceeding.
equity loans and HELOCs both use the equity in your home—that
is, the difference between your home’s value and your mortgage balance—as
Because the loans are secured against the value of your home, home equity loans
offer extremely competitive interest rates—usually close to those of first
mortgages. Compared to unsecured borrowing sources, like credit cards, you’ll
be paying far less in financing fees for the same loan amount.
there’s a downside to using your home as collateral.
Home equity lenders place a second lien on your home, giving them the right to
eventually take over your home if you fail to make payments. The more you
borrow against your house or condo, the more you’re putting yourself at risk.
Banks underwrite second
mortgages much like other home loans. They each have guidelines
that dictate how much they can lend based on the value of your property and
your creditworthiness. This is expressed in a combined loan-to-value, or CLTV,
suppose you’re working with a bank that
offers a maximum CLTV of 80%, and your home is worth $300,000. If you currently
owe $150,000 on your first mortgage, you may qualify to borrow an additional
$90,000 in the form of a home equity loan or HELOC ($300,000 x 0.80 =
Like other mortgages, your eligibility for a loan and interest rate depend on
your employment history, income, and credit score. The higher your score, the
lower the risk you pose of defaulting on your loan and the lower your rate.
equity loan comes as a lump sum of cash. It’s an option if
you need the money for a one-time expense, like a wedding or a kitchen
renovation. These loans usually offer fixed rates, so you know precisely what
your monthly payments will be when you take one out.
equity loans aren’t the answer if you only need a small infusion of cash. While
some lenders will extend loans for $10,000, many won’t give you one for less
than $25,000. What’s more, you have to pay many of the same closing costs
associated with a first mortgage, such as loan-processing fees, origination
fees, appraisal fees, and recording fees.
require you to pay “points” – that is, pre-paid interest – at closing time.
Each point is equal to 1% of the loan value. So on a $100,000 loan, one point
would cost you $1,000.
lower your interest rate, which might actually help you in the long run. But if
you’re thinking about paying off the loan early, that upfront interest doesn’t
exactly work in your favor. If you think that might be the case, you can often
negotiate for fewer, or even no, points with your lender.
Home equity lines of credit are a bit different. They are a
revolving source of funds, much like a credit
card, that you use as you see fit. Most banks offer a number of
different ways to access those funds, whether it’s through an online transfer,
writing a check or using a credit card connected to your account. Unlike home
equity loans, they tend to have few, if any, closing costs and feature variable
interest rates – though some lenders offer fixed rates for a certain number of
pros and cons to the flexibility that credit lines offer. You can borrow
against your credit line at a later date without having to apply for a new
loan. In that way, it’s a nice emergency source of funds, as long as your bank
doesn’t require a minimum draw when you close the loan.
HELOCs can get some borrowers into
trouble. Regardless of your intentions when you open the credit line, it’s easy
to spend the available funds on things you don’t need. And whatever you do use,
of course, you have to pay back with interest.
equity lines have two phases: During the draw period – typically 10 years
– you can access your available credit as you see fit. Many HELOC
contracts require small, interest-only payments during this period, though you
may have the option to pay extra and have it go against the principal.
draw period ends, you can sometimes ask for an extension. Otherwise, the loan
enters the repayment phase. From here on out, you can no longer access additional
funds and you make regular principal-plus-interest payments until the balance
disappears. During the 20-year repayment period, you must repay all the
money you’ve borrowed, plus interest at a variable rate. Some lenders give
borrowers the option of converting a HELOC balance to a fixed interest rate
loan at this point.
payment can almost double. According to a study conducted by
TransUnion, the payment on an $80,000 HELOC at 7% annual percentage rate will
cost $467 a month during the first 10 years when only interest payments are
required. That jumps to $719 a month when the repayment period kicks in.
in payments at the onset of the new period has resulted in payment shock for
many an unprepared HELOC borrower. If the sums are large enough, it can even
cause those in financial straits to default. And if they default on the
payments, they could lose their homes.
Home Equity Loan
credit line for a pre-approved amount; contract may require a minimum draw at
interest-only payments during “draw” period, following by full monthly
adjustable, though banks may cap your rates or offer a fixed rate for a
specific period of time
may charge upfront “points” that lower your interest rate
not use points
to a first mortgage; typically 2%-5% of loan amount
applicable, closing costs tend to be smaller than those of one-time loans
to draw on credit line whenever you need it; don't pay interest on money you
higher interest than HELOCs because of fixed-rate feature; lack of
borrowers may be tempted to use loans for non-essential purchases
needs where you know exactly how much you need
where you need access to funds at different times
Homeowners can use their home equity loan or HELOC for a wide
range of purposes. From a financial planning standpoint, one of the best things
you can do with the funds is to use them for renovations and remodeling
projects that increase the value of your home. This way, you’re rebuilding the
equity in your home while simultaneously making it more livable.
also use the money to consolidate high-interest
rate debt, including credit card balances. You’re effectively
replacing a high-cost loan with a secured, low-cost form of credit.
course, you can also borrow to fund an overseas vacation or that new sports car
you’ve been eyeing. Whether it’s worth eroding your equity in order to make
discretionary purchases is something to which you’ll want to give some serious
There’s another advantage to tapping your equity if it's for
home-renovation projects: The IRS lets
you write off some of the interest on those loans, as long as you itemize
2018, couples can deduct the interest on up to $750,000 of eligible
“acquisition debt” (or up to $375,000, if you file separately). Those are the
mortgages and home equity loans used to “buy, build or substantially improve” the
home against which it was secured.
to be able to deduct interest on up to $100,000 of home equity loans that were
used for other reasons, like paying down credit cards. But as of 2018, that’s
no longer an option through the end of 2025, a change due to the tax
legislation passed in Dec. 2017.
Even if property values stay flat or rise, every new loan
stretches your budget. If you lose your job, for example, it’ll be harder to
keep current on your payments. Because the lender has a lien on your home,
there’s a chance you could face foreclosure if you fall behind for a long
Lower cost than many other types of loans
The ability to borrow a relatively large amount of cash
Flexibility to use the money for virtually any purpose
Potential tax breaks if you use the funds on renovation projects
that increase the value of your home
The safety of fixed interest rates on home equity loans
When you use your home as collateral, you’re shrinking the
amount of equity in your home
If the real estate market takes a dip, those with higher CLTV
ratios run the risk of going “underwater” on their loan
Second mortgages aren’t the only way to tap the equity in your
home to get some extra cash. You can also do what’s known as a cash-out refinance,
where you take out a new loan to replace the original mortgage.
new loan is bigger than the balance on your previous one, you pocket the extra
money. As with a home equity loan or HELOC, homeowners can use those funds to make
improvements to their property or consolidate credit card debt.
does have certain advantages over a second mortgage. The interest rate is
generally a bit lower than that of home equity loans. And if rates have dropped
overall, you’ll want your primary mortgage to reflect that.
have drawbacks, too. You’re taking out a new first mortgage, so closing costs
tend to be a lot higher than HELOCs, which typically don’t have steep upfront
fees. And if refinancing means you have less than 20% equity in your home,
you may also have to pay primary mortgage insurance or PMI. That’s something
you may not have to worry about if you simply have a second mortgage tacked
onto your original loan.
doesn’t hurt to have your loan officer run the numbers for each option, so you
can better understand which one is best for your situation.
Loan options and fees vary significantly from
one lender to the next, so it pays to shop around. In addition to traditional
banks, you can also reach out to savings and loans, credit unions and mortgage
companies. You can also use mortgage brokers, who essentially do the
shopping for you and get paid by the lender.
never talk to only one lender. You need at least three options, and you might
also need the help of a mortgage professional to help you compare the offers.
If you already have multiple accounts at a bank, ask about better rates or
special promotions for existing customers.
for a loan from a traditional lender – a bank or mortgage company – depends on
the amount you're seeking. Generally, for loans under $100,000, a small
community bank or credit union will offer the best deal. For larger loans
($150,000 or more), talk to local and national banks along with mortgage
brokers. As with traditional mortgages, mortgage brokers can often offer the
best deals on home equity loans because of their relationships with multiple
lenders and investment pools. For "in-between" loans of $100,000 to
$150,000, "you just have to shop," says Casey Fleming, mortgage
broker and author of "The Loan Guide: How to Get the Best Possible
fooled by low teaser rates. Have the lender send the documentation that shows
the interest rate and closing costs for your specific loan. With home equity
loans, upfront fees can be steep – usually anywhere from 2% to 5% of your loan
Many of the fees a lender tries to charge aren’t set in stone.
Some lenders, for example, are willing to bend on loan-origination fees, which
cover the commission paid to the loan officer or broker. If they require
you to pay points on your loan, they may be willing to haggle on that, too. But
you have to ask.
may offer several options when it comes to locking in a fixed interest rate on
your HELOC. The longer the period of time in which you get a fixed rate, the
higher the interest rate they charge. But there’s also less risk on your part
if rates go up. So think carefully about which terms work best for you.
general, you’ll get the best terms if you have steady employment history and an
excellent credit score. As with any mortgage application, it’s a good idea to
check your credit reports ahead of time and make sure they’re free of
To avoid some serious heartache, later on, be sure to look over
all the loan documents carefully before signing on the dotted line.
have some recourse if you realize you’ve made a mistake, as long as you act
quickly. There’s a federally mandated three-day cancellation rule that applies
to both home equity loans and HELOCs.
have to notify the lender in writing. That notice has to be mailed or filed
electronically by midnight of the third day (not including Sundays) or it’s
Sometimes, even if you're granted a loan you can encounter
financial problems later on that make it difficult to pay it back.
Interestingly, while losing the home is a risk if you can’t pay back your
home equity loan or line of credit, it isn’t a foregone conclusion.
However, even if you can avoid losing your home you will face serious financial
to Springboard, a U.S. Department of Housing and Urban Development
(HUD)-approved counselor, lenders typically pursue a standard lawsuit to get
the money rather than going straight to foreclosure. That’s because, to
foreclose, the lender has to pay your first mortgage off before auctioning the
property. While a lawsuit may seem less scary then foreclosure proceedings, it
can still hurt your credit. Not to mention, lenders can garnish wages, try to
repossess other property or levy your bank accounts to get what is owed.
If the real
estate market takes a dip, those with higher CLTV ratios run the risk of going
“underwater” on their loan.
mortgage lenders and banks don’t want you to default on your home equity loan
or line of credit, so they will work those struggling to make payments.
The important thing is to contact your lender as soon as possible. The last
thing you should do is avoid the problem. Lenders may not be so willing to work
with you if you have ignored their calls and letters offering help for months.
comes to what the lender can actually do, there are a few options. Some lenders
will offer certain borrowers a modification of their home equity loan or line
of credit: the terms, the interest rate, the monthly payments or some
combination of the three to make paying off the loan more affordable.
(Note that extending the term of the loan may mean you pay more in the end, but
the monthly payments will drop.)
federal government has programs in place to help struggling borrowers with
their first mortgage and their home equity debt. In order to take advantage of
the government’s Second
Lien Modification Program, you had to have modified your first
mortgage under the Home Affordable Mortgage Program or HAMP. The Second Lien
Modification Program, in conjunction with HAMP, enables borrowers to lower the
payments on the home equity line of credit. HUD publishes helpful
information on these and other programs.
Because the documents checked for obtaining a HELOC are fewer
than for a regular mortgage – and because there's an extended period in which
you can borrow funds – criminals can, unfortunately, use HELOCs to
rob you. Of late, the number of thieves fraudulently acquiring these accounts
and siphoning out thousands of dollars by stealing identities and fooling
lenders has increased.
how it happens. Criminals get hold of your personal information through public
records. Next, they establish a HELOC internet account and manipulate the
customer account verification process in order to get funds – which of course
they never repay. Identity-theft experts have found that victims learn about
the crime only when the financial institution calls them about the late
payment, they receive written notification of late payment, or a marshal shows
up at their home to evict them.
they often prey on people who have already taken out HELOCs, anyone with equity
in their home can become a victim, especially homeowners with good credit and
seniors citizens who've paid off their mortgages (because lenders often readily
approve their applications). To reduce your risk, check your HELOC statements
regularly and examine your credit reports for any inaccurate information.
There may come a time in your life when access to a little extra
cash becomes a necessity. If so, a second mortgage is a compelling option.
Because they’re secured against the value of your home, lenders are willing to
offer rates that are lower than for most other types of loans.
because you can use your home as an ATM doesn’t mean you should. An extra loan
means an extra loan payment each month. And if you find yourself unable to hit
your due dates, you’re putting your home in jeopardy. So use home equity debt
wisely, if you conclude it's the best option for you.
Source: To view the
original article click here