When You Need to Use the Equity in Your Home…
When you need to exchange the equity in your home for cash, and assuming you have the income and the credit to obtain a new loan, you have three choices: A cash-out refinance, a Home Equity Loan or a Home Equity Line of Credit.
Assuming that you’d rather not refinance your entire home mortgage loan, you’ll probably choose to merely pull out the equity with a new, smaller loan.
First, the Home Equity Loan.
These carry lower interest rates than personal loans or credit cards, and the interest rates are fixed. That means you’ll get a loan for a set period of time with a predictable payment each month.
The most common reasons for obtaining a home equity loan are to pay for home improvements, to make a down payment on a second home or an investment property, to pay college costs when student loans are not available, or to consolidate debt. Using the cash to pay off high-interest credit cards and personal loans allows the borrower to pay down debt sooner, since less money will be going to interest payments each month.
Some, unfortunately, use the cash to fund a vacation or buy expensive toys – something no financial advisor would ever recommend.
A Home Equity Line of Credit (HELOC) is slightly different.
This loan acts like a secured credit card. In fact, if you choose a HELOC, you’ll even get a “credit card” to give you easy access to your money.
You have a set limit on how much you can borrow, and you pay interest only on the amount you owe each month. In most cases the interest rate will also be variable, so your minimum monthly payment can vary from month to month. Some lenders offer low introductory rates on HELOCs, after which the interest rate and monthly minimum payment can rise dramatically.
You can borrow the entire loan limit at the outset, or you can wait and take money out a little at a time or in a later lump sum. Most HELOCs have a loan term of from 5 to 20 years, after which payment in full is due.
Qualifying is similar for both loans.
You’ll need a sufficient amount of equity, a credit score in the upper 600’s or higher, and an adequate debt to income ratio.
Most lenders will allow you to borrow 80% of your home’s equity, and some will allow 90%. For example, if your house is worth $300,000 and you owe $200,000, you have $100,000 in equity. Most lenders will allow you to borrow $80,000, while some will lend $90,000.
As with all loans, the higher your credit score, the lower the interest rate you’ll be required to pay.
Different lenders have different requirements for debt to income, but in general, it should not exceed 43% of your gross monthly income.
What is a debt-to-income ratio? This is a simple equation in which you divide your monthly debt obligations by your monthly income. $1,000 in monthly debt divided by $3,000 in monthly income yields a 33% debt to income ratio.
Should you choose a Home Equity Loan or a Home Equity Line of Credit?
A Home Equity Loan is the right choice if you know how much you want to borrow from the outset and prefer the security of a fixed interest rate and a set monthly payment. Since interest rates are rising slightly, this is a huge benefit for many.
A HELOC may be better if you’re unsure about the amount needed – as when starting a home remodeling project.
A home equity loan can also give you income tax benefits. Under the Tax Cuts and Jobs Act, you can deduct the interest paid on (combined) loans of up to $750,000 for a married couple of $375,000 for an individual as long as the money was used to buy or improve a first or second residence.
A home equity loan can be a good thing – as long as the money is used wisely.
The question to ask yourself is whether spending the money you’ll take out of your home’s equity will give you a long term benefit.
If the answer is yes, then give us a call at Homewood Mortgage – the Mike Clover Group. We’ll be pleased go over the numbers with you and show you your options.
Call today: 800-223-7409