When your expenses exceed your income, that’s a time to generate more funds. The various ways that may come to your mind, like finding a new job or waiting for your investment to mature, might be too time-consuming.
But those are not the only to improve your financial situation and deal with your expenses. If you are living in a home and own significant home equity, you can obtain a home equity loan.
Learn About Home Equity Loan
A Home equity loan enables you to leverage the homeownership that you have obtained through a down payment and mortgage to borrow money against it.
This is an additional loan to the primary mortgage you obtained to buy your existing property. That is why the home equity loan is also called a second mortgage.
One of the things which you might want to know is defaulting on the loan may lead to home foreclosure. Once the property is sold, the first mortgage lenders get the priority to recover their losses. After they are done, the second mortgage lender can use the remaining proceeds to cover your outstanding debt.
How Does Home Equity Loan Work?
Once you hit the jackpot and managed to make ends meet with the lenders, the fun begins. But how much home equity loan are you getting?
We’ll example with an example to help you understand how much you can make from your home equity deal. Suppose you have a home worth $500,000, and you own $200,000 of home equity. To assess your home value, you may need to get a home appraisal.
It is also important to check and discuss the loan-to-value (LTV) ratio at which the lender is offering the loan. If you get a generous LTV ratio of 80%, the lender considers your home value to be $400,000 ($500,000 x 0.80).
Since you own $200,000, the remaining $300,000 is still outstanding. According to home equity calculations, you need to subtract the outstanding home equity from the home value offered by the lender. So, your home equity loan can go up to ($400,000 – $300,000) $100,000.
| Calculating the Second Mortgage | |
|---|---|
| Total Home Value | $500,000 |
| Loan-to-Value Ratio | 80% |
| Outstanding Home Equity | $300,000 |
| 80% of $500,000 | $400,000 |
| $400,000 – $300,000 | $100,000 |
| Total Second Mortgage | $100,000 |
Home Equity Loan Requirements
A home equity loan is not something you are guaranteed. The lender assesses various aspects to decide if you will be able to repay the loan or default.
There are also some criteria that make you eligible for the loan. These include:
- FICO credit score of 680 or over.
- A debt-to-income ratio of 45% or below
- Minimum home equity of 10%
What are the Pros and Cons of a Home Equity Loan?
After all this discussion about home equity loans, you may still be unsure about one thing, the pros, and cons of home equity loans. That answer can help you decide whether you want to opt for the home equity loan or try a different mortgage.
We will discuss the positives and potential downsides of home equity loans.
Advantages of Home Equity Loans
As we are at the part where we discuss the pros and cons of a home equity loan, let’s begin by discussing the benefits first.
Friendly Interest Rates
When we compare the pros and cons of a home equity loan with other financing options, the interest rate is one of the first things you would want to know.
Home equity loan lenders usually offer a lower interest rate as compared to some other loans. A major reason for this is the lenders know they have a lien over your property. So, in case of a loan default, they can recover the damage by foreclosing and selling your property.
Easier to Budget
Apart from offering a low mortgage, the interest rates for home equity loans are also fixed. This brings predictability to your monthly expenses and helps you create an efficient budget because you know how much you will spend on your mortgage payments.
Longer Loan Repayment
Home equity loan lenders usually offer flexibility in repayment. Your loan period can go up to 30 years as well, ensuring that your monthly mortgage expense is not too high.
This makes it easier to timely pay off your mortgage and avoid property foreclosure.
Disadvantages of Home Equity Loans
Just like anything, there are pros and cons for home equity loans. As we have talked about the advantages above, we will now discuss some of the downsides.
Higher Monthly Mortgage
Remember, a home equity loan is not your first mortgage. You still have to repay the first mortgage loan, which was approved to buy your home.
This can be considered in the pros and cons of a home equity loan. The benefit is that your monthly mortgage will be predictable due to a fixed cost. But at the same time, you need to amp up your sources of income as you will need to make multiple mortgage payments.
Inflexible Markets
Your lender offers the home equity loan based on your property value at that time. If the real estate market takes a downturn and your property value decline, you will be paying more than your property is worth.
You are probably thinking, “So what? I am not paying anything extra.” That is right, your mortgage payments remain the same. But when you decide to sell the house, it will be hard to earn a profit from your sale.
Current Property at Risk
Opting for a second mortgage to cover your expense is a massive gamble, as the lender has a lien over your property. If you are not able to pay timely mortgage payments, this may lead to you losing your home.
That is why when you are going for a home equity loan, make sure you have a stable income to pay your mortgage as per schedule.
The Final Word
A home equity loan can be a good way to increase your finances and borrow money. Now that you know the details, along with the pros and cons of home equity, it will be easier to decide whether to opt for it or not.
If that is the option you want to go for, HAR is one of the best options to go for. We are a Texas-based real estate to assist aspiring homeowners in achieving their dreams.
DISCLAIMER OF ARTICLE CONTENT
The content in this article or posting has been generated by technology known as Artificial Intelligence or “AI”. Therefore, please note that the information provided may not be error-free or up to date. We recommend that you independently verify the content and consult with professionals for specific advice and for further information. You should not rely on the content for critical decision-making, as professional advice, or for any legal purposes or use. HAR.com disclaims any responsibility or liability for your use or interpretation of the content provided.
