Home Equity Loans FAQ's - Help and Information on Home Equity Loans

Home Equity Loan FAQ's

What is home equity?
Home equity is the part of your home that you actually own. You can calculate your home equity by taking the home's value and subtracting your mortgage or mortgage balance. If your home is valued at $250,000 and you have a $150,000 mortgage balance, your home equity is $100,000.

What is a home equity loan?
A home equity loan is loan that is secured by your home. If you default on a home equity loan, you could and will probably lose your home.

What is a second mortgage?
A second mortgage is another name for a home equity loan. The mortgage on your home is your first mortgage and a home equity loan would be your second mortgage.

What are the disadvantages of a home equity loan?
Your home is on the line and if you default on payments you could lose it. There are costs to take out a home equity loan. You will pay money both in interest and fees when you take out a home equity loan.

What are the advantages of a home equity loan?
The two major advantages of a home equity loan are tax savings and a lower interest rate.

The interest rate you pay on a home equity loan is lower than the interest rate you will pay on your credit cards by 7% to 10% or more. Home equity loans also have a lower interest rate than personal loans and other types of non-secured debt or loans.

For home equity loans, you can generally deduct the interest you pay on the first $100,000 you borrow. For purposes of home improvement or to buy another home, you can deduct even more money. However, the interest you pay on a credit cards and personal loans is usually not tax deductible.

What may I use a home equity loan for?
You may use a home equity loan for anything. Common uses include home improvements, debt consolidation (paying off high-interest credit card debt), paying for an education and buying luxury items. You can also use a home equity loan to pay for medical emergencies or as a business investment or to buy another property.

How much can I borrow?
Lenders will usually let you borrow up to 80% of your home's value minus your mortgage. This means that if your home is worth $200,000 and you have a mortgage of $100,000, you will be allowed to borrow $60,000 ($200K * 80% - 100K=60K). The lender is allowing you to borrow up to a loan-to-value (LTV) ratio of 80%.

Almost all lenders will only allow an 80% LTV, some lenders allow an 80% to 90% LTV, and some lenders even go as high as an LTV of 125%. As you go above an 80% LTV, the cost of the loan increases because of larger risk to the lender.

Are there good and bad uses for a home equity loan?
Yes. Good reasons to take out a home equity loan are for debt consolidation, home improvements or to a pay for an education. In these cases your money grows. Poor reasons to take out a home equity loan are to buy luxury items or to fund living expenses. In these cases, your home equity is spent on something that depreciates.

What will lenders look at if I apply for a home equity loan?
Lenders will look at your credit history, how much you are borrowing compared to how much equity you have in your home, how much you spend each month to pay other debts, your employment history as well as what you plan to do with the loan.

How long will a home equity loan take to close?
You should be able to close a home equity loan within two to three weeks after the application.

What are the types of home equity loans?
There are two types of home equity loans. A standard home equity loan (also called a term loan, a closed-end loan or a second mortgage installment loan) and a home equity line of credit.

A standard home equity loan is a like a traditional loan in which you are loaned a lump sum of money and you pay that money off in fixed payments at a fixed interest rate over the duration of the loan.

A home equity line of credit works like any other line of credit but this one is secured by your home. You have a maximum amount you can borrow. The interest rate is variable and you pay interest on only the amount that you borrow. You credit is revolving which means that as you pay off borrowed money, you can borrow that money once more.

Is there any other way I can borrow from my home equity?
Yes. Cash-out refinancing is not a home equity loan but it let's you borrow from your home's equity. In cash-out refinancing, you refinance your mortgage for an amount that is greater than your mortgage. The difference between your new mortgage and your old one is like a home equity loan.

Let's say your home is worth $150,000 and you have a $50,000 mortgage. If you refinance your mortgage at today's low interest rates for an amount of $60,000, you can pay off your old mortgage of $50,000 and the difference of $10,000 is your home equity loan. You now have a new mortgage of $70,000.

What are the advantages and disadvantages of the different ways I can borrow from my home's equity?
Home equity loans are more stable since they have a fixed interest rate and payments. They also have less fees and charges than home equity lines of credit. The amount of money that you will pay in interest is fixed and this is very advantageous to those who may have less financial discipline. Home equity loans are suited to borrowing large sums in which the entire amount is needed right away.

Home equity lines of credit are useful when you need money at intervals or you do not know how much you will need. Home equity lines of credit are also useful when you borrow a small amount and pay it back quickly. Two use of a home equity line of credit might be to pay a college tuition or for open-ended repairs. Home equity lines of credit can result in an undesirable "balloon" payment if only minimum payments are made. Home equity lines of credit should not be used for debt consolidation. Home equity lines of credit usually have a lower interest rate than fixed-rate home equity loans.

Refinancing has the advantage of a lower interest than a home equity loan but it has the disadvantage of having higher closing costs. A home equity loan generally has a shorter term than refinancing a mortgage. Refinancing usually takes a few weeks longer to close than a home equity loan.

What is a balloon payment?
A balloon payment is a lump sum payment that is due to clear up an outstanding balance at the end of the duration of a home equity loan. A balloon payment can be created if you take out a home equity line of credit and you have made minimum or partial payments on the amount owed. When your home equity line of credit expires, you then owe a "balloon" payment to clear the outstanding balance.

A balloon payment is often thousands of dollars and should be avoided as much as possible. To make the balloon payment you may have to sell your home, take out another loan or refinance the balloon amount, or come up with a large sum of money somehow.

What are the costs involved in taking out a home equity loan?
The money paid in interest is usually the biggest cost in a home equity loan. You may also pay fees which consist of points and closing costs. Points are one time fees that are paid at closing; one point is one percent of the loan amount. Closing costs will include costs for such things as attorney fees, appraisal fees, credit report fees and mortgage preparation fees. Closing costs are generally between 2% to 5% of your loan amount.

How can I compare different loans?
The APR, or annual percentage rate, is the single most important thing to compare when shopping for home equity loans because it takes into account both interest and fees. The APR, which is showed as a yearly rate, factors in the loan interest rate and all fees paid to get the loan. Usually, the lower the APR, the lower the cost of your loan. When comparing APR's between loans, make sure the other terms and conditions of the loans are the same.

You cannot compare the APR of a home equity loan to the APR of a home equity line of credit. This is because the APR of home equity loan takes into account the interest rate and all fees paid whereas the APR for a home equity line of credit takes only into account the interest rate. Fees in a home equity line of credit are not factored into the APR.

Why do I not want a "no closing cost" option?
A "no closing cost" option may mean that you are not paying closing costs up front and your interest rate has increased. If you are financing your closing costs, you will pay more in closing costs since you are now paying interest on top of your closing costs. Make sure you understand the exact repercussions of this option.

Are there things to be aware when shopping for a loan?
Yes. Some dishonest lenders will try to make maximum profit at your expense. They may help you get a loan you can't afford or overcharge you. Beware of these shady dealings and lenders.

Are there loan terms to be aware of?
Yes. A pre-payment penalty, credit insurance, and an interest rate increase in cases of default can make a loan much more expensive.

A pre-payment penalty is a penalty paid to the lender if you pay off the loan earlier. Credit insurance, which is optional, can pay off the loan if you die. An interest rate increase in cases of default increase the loan interest rate for the rest of the loan term if you miss a payment or if pay late. If these terms are in your loan, make sure you understand them completely.

Are there things I have to do when I shop for a loan?
Yes. Negotiate and comparison shop and let your lender know you are doing it.

Lenders and brokers may offer different prices for the same home equity loan terms to consumers, even if those consumers have the same loan qualifications. The most likely reason for this difference in price is that loan officers and brokers are allowed to keep some or all of this difference as extra compensation or commission.

When you have received a loan offer, ask the lender to lower the interest rate, waive or reduce one or more of its fees, an/or lower points. Make sure that the lender does not lower one fee while raising another or lower the rate while raising points.

Comparison shop to make sure your loan offer is reasonable.

What must I do at closing?
Make sure you read and understand the entire loan document and do not just glance over the paperwork. Try to read the loan documents before you meet and sign the papers. If you are not comfortable with the terms and you can't have them changed, don't sign it.

You must also know that you also have three days after you sign the loan papers to change your mind and cancel the loan for any reason.