May 14th, 2018 7:04 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, are confusing to some
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.
draw period ends, the outstanding balance must be repaid. Typically, the
repayment period is a 15-year term.
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
good and bad 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
A home equity
loan, like a first mortgage, allows you to borrow a specific sum for a set term
at a fixed or variable rate. That’s why these loans are sometimes called second
loans aren’t common, but some banks offer them.
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.
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.
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 they are 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
“If you 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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