The home equity loan is a type of loan that homeowners can obtain by offering their homes as collateral. This loan is only provided to homeowners that have a home with a fair value in the market that is over the remaining loans and mortgages on the home.
This means homeowners who want to obtain a loan on their home with a fair market value equal to the number of loans on the house will not be granted home equity loans.
There are two main types of home equity loans, the fixed-rate home equity loan and the home equity line of credit. The fixed-rate home equity loan is a lumpsum amount of loan provided to homeowners with a fixed interest rate.
This is a more common type of home equity loan. This loan can be beneficial for homeowners who want to obtain a lump sum amount of loans for a lower interest rate than the market rate for unsecured loans.
Home equity line of credit is a type of home equity loan where variable amounts of loans are provided at the homeowner’s discretion. A limit is set for both minimum and maximum withdrawal amounts and a withdrawal period is set.
Within that period, the owner can take any amount of time at any time as long as the aggregate amount of loan is below the maximum limit. The interest rate in this type of home equity loan varies according to the interest rates of the market.
This is an ideal home equity loan for homeowners who don’t want to take a lump sum amount of loans and don’t want to pay interest on amounts they are not using.
Tips for Applying for Home Equity Loan
When applying for home equity loan, homeowners should follow 9 tips as below:
1. Evaluating different options
When applying for home equity loan, homeowners should evaluate their options.
While home equity loans are a great option and can easily be obtained due to the security being provided, it can also result in a loss of the home in case of a default in payments.
The opening and closing fees of home equity loans may also be considered high by some homeowners. Therefore, before applying homeowners should consider all the available options they have.
Homeowners have many different options when it comes to obtaining loans. Instead of opting for home equity loans, homeowners can obtain other types of loans such as personal loans and credit cards.
While the interest rates on these may be higher than home equity loans because no securities are provided for these loans, they will not result in losing homeowners’ home.
Another alternative to home equity loans but similar is the cash-out refinance. In a cash-out refinance, the mortgage of the home is refinanced and money is given out to the homeowners.
The loan amount is aggregated with the new mortgage balance of the house.
This is similar to home equity loan as in this type of loan, the home is also provided as security. The cash-out refinance provides lower interest rates than home equity loans but have higher closing costs.
2. Checking credit score
Home equity loans are easily obtainable for homeowners with different credit scores.
This is mainly due to the equity on the home of the owners, that is being offered as collateral, reducing the risks associated with loan recoverability for lenders.
In case of a default in the payments on the loan, lenders can easily recover their loans by auctioning the home offered as collateral.
Although the credit score requirements for obtaining a home equity loan are much lower than other forms of loan, it still affects other factors of the loan such as the borrowing limit and the interest rates.
For example, if a homeowner has a low credit rating than required, their loan request may outright be rejected or if a homeowner has a low credit rating then optimal, they will be provided a smaller amount of loan at a higher rate than someone who has a better credit rating.
Lenders will also perform other extensive checks such as assessing the borrower’s ability to repay the loan.
Lenders are required by law to perform these checks to ensure that the loan will be repaid. Borrowers will need to provide documentations to demonstrate their ability to repay the loan.
These may include tax records, statements of proof of income, bank statements, etc.
3. Understanding Loan To Value (LTV) ratio
The loan to value ratio is used to calculate the value of the loan in comparison to the value of the asset being provided as security. In the case of a home equity loans, it is the amount of loan that is awarded to the borrowers based on the value of their homes.
Lenders try to keep the ratio between 80% and 90%. The value of the home is usually obtained by performing a proper valuation through a real estate agent.
For example, if the fair value of the home is $200,000 and the lender tries to maintain an 80% loan to value ratio, the expected loan amount will be $160,000.
However, the value of remaining mortgages and loans taken on the home are deducted from the amount first. So, if the remaining mortgage on the home is $120,000, the amount of loan provided will be $40,000.
4. Evaluating different lenders
As with any other type of loan, there are many different lenders in the market that provide home equity loans to homeowners. All lenders will have different requirements and offer for providing the loan.
This will affect the amount of repayment that borrowers will have to make. Evaluating different lenders and finding the optimal lender can save borrowers thousands of dollars in cash.
The optimal lender is one that offers the loan at the lowest rate and lowest costs while also meeting all the demands of the buyer. Borrowers will have different reasons why they are taking a loan.
So, it is important that buyer choose the lenders that can meet their requirements.
It is recommended for borrowers to check different details about the lenders such as the interest rates they offer, lengths of the plans offered, fees other than interest and principal payments, etc.
5. Choosing type of home equity loan
Buyers should also consider the different types of home equity loans and consider the one that meets their requirements.
As mentioned above, there are two main types of home equity loans, the fixed-rate home equity loan, and the home equity line of credit.
Buyers should consider the differences between these types and consider which one suits their needs.
For example, if a buyer requires large amount of loan upfront, they can consider the fixed-rate home equity loan.
However, if buyers are not interested in obtaining large amounts of loans upfront, because they don’t want to pay interest on amounts which they won’t use, they can consider taking the home equity line of credit which is more flexible.
6. Making plans for the cash
Homeowners, before acquiring loan, should make plans for the cash that they want to take as home equity loan.
This will make it easier for homeowners to determine the amount they want to receive, the type of lenders that will meet their requirements, and the type of home equity loan they need to obtain.
For example, if the homeowners want to acquire a home equity loan for home renovations, then a fixed-rate home equity loan will be more attractive to them than a home equity line of credit.
In contrast to smaller expenses, a home equity line of credit might be more suitable.
7. Tax planning
Homeowners should also determine any tax savings they can obtain from using home equity loans.
Homeowners are allowed tax deductions for interest payments on home equity loans as long as these payments are made for home improvements.
Homeowners can assess whether acquiring a home equity loan can be more tax beneficial to them than using their own cash or other forms of loans for home improvements.
8. Paying off existing debt
Homeowners can also determine whether they can use the loan received from home equity loan to pay off existing debts.
This can benefit the homeowners if they can use a lower interest rate home equity loan to pay off debts that have a higher interest rate.
For example, if the homeowner has credit card debts at a high interest rate, they can acquire a home equity loan at a lower interest rate and pay off the credit card debts, essentially, consolidating the interest rates.
9. Comparing costs and benefits
After taking into consideration all the costs and benefits of the home equity loan, homeowners should make a final decision about whether the benefits of the home equity loan outweigh its costs.
Ultimately, home equity loans can only be beneficial if they provide more benefits to the borrowers than they cost. Homeowners should also consider the risk of potentially losing their homes when considering the costs and benefits.
Conclusion
The home equity loan can be acquired by homeowners against their home equity. Home equity loans have two main types, the fix-rate home equity loan and the home equity line of credit.
Homeowners must follow some tips for applying for a home equity loan. Homeowners should evaluate other loan alternatives, check their credit scores, understand the loan to value ratio, and evaluate different lenders.
Furthermore, they should determine the type of home equity loan they require and make plans for the cash beforehand.
Homeowners can also determine tax benefits or whether they can use the loan to consolidate other high-interest loans and make a cost vs benefit analysis of whether the loan should be taken.
