What is a home equity loan?
Tuesday, 24 April 2018
There are several ways to borrow money, and using the equity of your home is one of them.
A home equity loan can be used for just about anything, including consolidating debt, paying for home improvements, or funding any other major expenses.
Before you consider a home equity loan or line of credit, it's important to understand how they work. It's also important to understand the risk. When you use your home as collateral for a loan, the lender could force you to sell your home to satisfy the debt if you do not pay your monthly payments.
Here are things you need to know:
What is home equity?
Home equity is the value of ownership built up in a home that represents the current market value of the house, less any remaining mortgage payments. This value is built up over time as the homeowner pays down the mortgage and the value of the property appreciates.
In other words, the equity you have in your home is the value of the home you've already paid for. For example, if your home has a current market value of $300,000 and you owe $100,000 on your mortgage, you have $200,000 in equity, assuming there are no other liens on the property.
Home-equity borrowing is using the equity in your home as collateral for a loan. A home-equity loan is also called a second mortgage, with a first mortgage being the original loan you received when you purchased the property.
Benefits of a home equity loan
Using your home's equity can be an affordable way to borrow, if you can get a low interest rate. Because the loan is secured by the equity in your home, you could possibly get a lower rate than with an unsecured loan or credit card.
A locked-in rate and monthly payments can also be a benefit. With a home-equity loan, you borrow a lump sum of money at a locked-in interest rate and make set monthly payments for the entire term of the loan, giving your budget some predictability.
Another attractive feature: The interest you pay on your home equity loan could be tax deductible, but you should always consult your tax professional regarding the deductibility of interest.
Most lenders use something called a loan-to-value ratio to determine how much you can borrow. This is the total amount of your loans as a percentage of your home's total value. Most lenders prefer to keep the loan-to-value ratio under 75 percent.
Let's do the math, using the example of a house with a market value of $300,000 and a loan-to-value ratio of 75 percent.
|Current market value of home:||$300,000|
|Loan-to-value ratio:||x 75%|
|Maximum loan amount:||$225,000|
|Minus the amount owed on original (first) mortgage:||-$100,000|
|Maximum amount of home equity available:||$125,000|
This example is for informational purposes only. Many other factors, such as your credit score, income, and other debts will be taken into account by your lender to determine how much you can borrow.
Getting a home equity loan
You will be required to complete an application, and your credit, debts, and income will be reviewed and verified. Your home will be appraised to determine its value. The process is similar to getting a first mortgage, and in most cases, the lending process can take from 10 to 60 days, depending on your lender and other factors.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial advisor about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
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