Home equity loans and HELOCs may look similar because they are two ways to get the money you need by taking advantage of your home equity, but they differ when it comes to money, repayment and structure. Here is a guide on equity loans, how they differ and when to use one over the other.
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What do you know about equity loans?
Equity loans, also known as home equity loans or second mortgages, are loans that allow borrowers to borrow money by taking advantage of the equity of their home, or the value difference between the current market value and the remaining mortgage balance. Equity loans come in two forms: real estate equity loans and HELOCs. In both, your equity acts as security for the lender, so if you fail to make your monthly payments, you risk losing your home.
In general, the total amount you can borrow is based on the loan-to-value (LTV) ratio — the amount you borrow divided by the value of the property — with a typical limit of 85 percent of equity. However, the amount you will be awarded depends on factors such as credit score, annual income, and payment history.
Home equity loans work similarly to a second mortgage and come with fixed monthly payments. These loans can be used for things like home improvement projects, college education financing, debt consolidation, or long-term investments. HELOCs are lines of credit, which makes them useful for larger, longer-term home improvement projects, and they usually come with a variable interest rate, but some lenders may offer fixed rate options.
Capital loans are useful if you own property in your home and use them to finance a project that will increase the value of your home in the long run, or if you want to consolidate high-interest debt.
Eligibility requirements to buy a home
While the eligibility criteria will likely vary depending on the lender, there are some general requirements that most lenders require. Here is a list of standard requirements:
- Debt-to-income ratio of at least 43% or less.
- A good credit score, at least in the mid-60s.
- Sufficient and stable income.
- Payments date on time.
- At least 15-20 percent of the equity in your home.
Home Purchase Loans
A home equity loan is a secured loan that is backed by the equity of your home. They often come with a fixed repayment period of five to 30 years and a fixed interest rate that depends on your financial history. Home purchase loans are financed in one go and can be used to finance any project, investment or purchase.
Over the life of the loan, if your credit score improves because your monthly payments are made in full and on time, your interest rate can be lowered, and if it is used to significantly increase the value of your home, the interest may be tax-deductible.
Pros of Home Purchase Loans
- It usually comes with lower interest rates than other forms of consumer debt.
- If used in certain situations, the interest can be tax deductible.
- You can use the money the way you want.
Disadvantages of home purchase loans
- Most of them have high home ownership requirements (15 to 20 percent).
- You risk losing your home if payments are not made.
- If the value of your property drops, you may end up paying more than the value of your home.
Home Equity Lines of Credit (HELOC)
A real estate equity line of credit is an equity loan that functions as a line of credit and is similar to a credit card. You can borrow a certain amount and get the amount you need when you need it. With HELOC, you are not limited to a specific payment period and can make payments when withdrawing funds. Interest rates are generally variable, but some lenders may offer fixed rate options.
HELOCs have a 10-year withdrawal period and a repayment period that typically lasts between 10-20 years. During the withdrawal period, you are only required to make interest payments and have access to the funds. During the repayment period, you do not have access to your funds and are responsible for paying both the interest and principal payments.
- You can only borrow as much as you need.
- Flexible payment options.
- If used in certain situations, the interest can be tax deductible.
HELOCs . Cons
- Variable interest rates can change at any time.
- You risk losing your home if payments are not made.
- Since it is a long-term line of credit, you risk more debt to pay off if spending is not closely monitored.
Home Purchase Loans vs. HELOCs
Home equity loans can look the same as HELOCs, but they are different ways to borrow money from the equity in your home. Here are some of the key differences between home equity loans and HELOCs.
HELOCs . Home Ownership Loans
|loan terms||5-30 years||Withdrawal period: 10 years Repayment period: up to 20 years|
|Terms of payment||Payment starts as soon as the money is spent||interest payments only during the withdrawal period; Principal and interest during the repayment period|
|Finance||disbursed at once||Withdraw any amount when needed|
|monthly payments||Same payment every month||Varies according to time and balance due|
Why use your proprietary rights?
If you have a stable, stable income, a sound credit history and are in good financial health, taking advantage of your home ownership can be a convenient way to get the cash you need at low interest rates. Because home purchase loans are secured and backed by your home, they often come with lower interest rates than unsecured forms of debt, such as credit cards or personal loans. It’s also common to use home equity loans to consolidate high-interest debt, as lower rates can save you money in long-term interest.
Stock loan tax deductions
Due to the Tax Cuts and Jobs Act of 2017, whether or not you can deduct interest charges depends on when you borrowed the loan, how much you borrowed, and how you use the money. To deduct interest charges from your taxes, the loan must be used to “purchase, build or substantially improve” the home that the loan supports.
Joint applicants who borrowed from their home equity after December 15, 2017, can charge interest up to $750,000, and separate applicants can deduct interest up to $250,000 from eligible loans. Joint applicants who took out loans to purchase homes before December 15 can deduct up to $1 million, and separate applicants can deduct up to $500,000. These limits also apply to existing mortgage loans as well, so if you have an existing mortgage, this will reduce the amount you can deduct.
Home Ownership Loans vs Refinancing
When you refinance, you get a new mortgage loan that replaces your previous mortgage. Most borrowers refinance to get a lower interest rate or new terms, so it only makes sense to refinance if you offer a lower interest rate or a loan on better terms. I am not responsible for paying off the first mortgage; The new lender will, and will continue to make loan payments as scheduled, only with the new lender.
Refinancing is also referred to as rate and term refinancing or cash refinancing. Here’s the difference between the two:
- Refinance price and term Changes the interest rate or term of the mortgage. It does not involve utilizing equity in exchange for cash, and holders of good credit are more likely to benefit from refinancing based on price and term.
- cash refinancing gIt gives the borrower cash for the difference between two mortgages. Cash refinancing only makes sense when the new mortgage covers an amount greater than the old mortgage.
Both refinancing loans and home purchase loans are ways to get the money you need by taking advantage of your home equity, but refinancing and equity loans are used in different situations. Here’s when to consider refinancing, and when to take out a home loan.
When to refinance
Refinancing is best for borrowers who:
- They plan to stay in their current home for an extended period of time, or if the value of the home increases.
- You need a lump sum of money for larger, planned expenses.
- You do not have excellent credit.
When do you get a home loan?
Equity loans are best for borrowers who:
- They built large stocks in their homes.
- Have excellent credit scores.
- Have a sound financial history and payment history.
How to get a stock loan
Here are 4 steps to follow when applying for a home loan:
1. Check your credit score, financial history and payment history
Before applying, be sure to know your credit score and check debt repayment history. If you have less than excellent balance and frequently miss payments, it will be difficult for you to get approved. To increase your chances of getting approved, take steps to improve your credit score and, if possible, improve your payment history by making at least minimal payments on your existing mortgage and debt.
Also calculate the debt-to-income (DTI) ratio. If you have a DTI above 50 percent (at most), it will be difficult to get approval for a stock loan. Focusing on paying off existing debt will lower your DTI, improve your credit score and improve your payment history.
2. Calculate your balance
To qualify for most equity loans, lenders will require you to have at least 20 percent of the equity — a maximum of 80 percent of the permanent value — in your home to be eligible for approval. Before applying, calculate your LTV ratio using a calculator, or by dividing the appraised value of your home by your current mortgage balance.
3. Consider potential risks
Before applying, consider the potential risks associated with an equity loan. If you default on the loan, you could lose your home to the bank. Review your financial situation, and see your past payments. How good are you at keeping up with your mortgage payments?
If you’re not on top of your monthly payments or are having trouble organizing your payments, speak with a financial advisor to help you decide if a home purchase loan is too risky for your personal financial habits.
4. Compare Lenders
Compare stock loan lenders by shopping to find the most competitive rates and terms for your financial situation. Once you find the lender that meets your needs and offers the best rates, check the eligibility requirements to make sure you qualify. Then, you can begin the application process, which can be done online or in person if the financing is through a bank or credit union.
To ensure a smooth application process, make sure that you are aware of the required documents and that you have what you need while applying.
loan repayment assistance
If you are having trouble making your monthly equity loan payments, contact the lender as soon as possible before you default on the loan. Once you default, that’s when you risk losing your home, and some lenders may offer forms of comfort such as reduced interest rates, revised repayment terms, or patience options. While this is not a given to every lender, it is worth checking before your loans go into default.
Once your loans go into default, the lender will constantly communicate with you via phone calls, letters or emails. If you receive a notification, call immediately. There is a possibility that the lender will be willing to modify the term of the loan or repayment if you can demonstrate that you are now able to make the monthly payments.
Helpful Home Ownership Resources
Here are some resources to help you get through the confusing process of borrowing a loan to buy a home:
Useful HELOC Resources
Here are some resources to help you get through the confusing process of getting a line of credit to buy a home:
While borrowing from your home ownership can be a risky move, it can pay off in the long run if you are dedicated to making the payments. Equity loans are great ways to borrow large amounts of money at low interest rates and can provide significant long-term benefits.
If you’re not sure whether to borrow a HELOC or a home loan, talk with a financial advisor to help decide which option best suits your financial situation, and whether an equity loan is a good idea overall. If a home equity loan is too risky or doesn’t meet your needs, you can apply for unsecured methods of borrowing like personal loans or credit cards to get the financing you need.
Once you’ve decided that an equity loan is the financing path you want to take, perform a financial audit to determine the equity loan that works best for you. Research the risks and benefits before applying, and compare lenders to find the most competitive rates for your situation. In the right situation, equity loans can be the best way to get the money you need.