When considering a home equity loan or second mortgage, do some research before jumping into the process. Unlike other loans, a home equity loan can be especially risky because of what's at stake.
On one hand, a home equity loan allows you to borrow a substantial amount of money, usually around 80% of the market value on the home (subtracting whatever is currently owed on the home). However, you must keep in mind that the most valuable and precious asset available, your home, is at risk if payments are not kept up.
If you are willing to take the risk, home equity loans can be quite advantageous. There are advantages and disadvantages of getting a home equity loan.
The Facts About Home Equity Loans
Essentially, a home equity loan is like a second mortgage. Like a first mortgage, you offer security or collateral for the loan in the form of your home. A home equity loan can come in two forms, the first being the term or closed-end loan.
With a closed-end loan, you can receive a lump sum of cash upfront from your lender that must be paid off over a fixed period of time at a fixed interest rate. Your payments will be the same each month. Once you've received the lump sum, you are not entitled to additional funds. Similar to a first mortgage, this loan enables you to know in advance exactly what your payments will be.
Before even considering a home equity loan, one of the first things you should look at are the fees associated with your loan, especially since home equity loans can be very tricky. Look at the fine print to make sure you are not going to be hit with any hidden fees or guidelines that will only end up hurting you dearly in the end. Also, don't be afraid to confront your lender with questions regarding your loan.
In fact, associated fees and rates can dropped or lowered by your lender, depending on the lender you choose. Keep in mind that home equity loans are an extremely competitive market. Finding a home equity loan should involve shopping around and haggling with lenders to try to get the lowest amount of fees. Types of fees can include upfront fees, closing costs, annual fees, etc.
HELOC Home Equity Loans
The other form of home equity loans is known as the HELOC, or Home Equity Line of Credit. With a HELOC, the lender decides in advance how much you can draw out in a given period of time. During that period, you can tap into your pre-approved line of credit whenever you need it. That means you only pay for the money that you actually borrow, instead of the total amount you are allotted by the lender. Use our Interest Only Loan Payment Calculator to compute a loan’s monthly interest-only payment, and see if that type of loan will work for you.
This type of home equity loan is a plus for those who are not sure exactly how much money they will require for ongoing projects. As you pay back your loan, your credit can be used over and over. For example, say you have a $35,000 line of credit. You borrow $15,000 and then several months later pay back $5,000, meaning there is now $25,000 still available.
The term loan is generally best suited for those who need cash for a one time project. In contrast, the HELOC, or line of credit, can be the best choice for those who have continuous projects and don't know the total amount they need to borrow.
Pros of Home Equity Loans
Obviously the biggest plus with a home equity loan is the having access to the amount of money that can be borrowed. Used wisely, a home equity loan can be a prime choice for getting through tough times. The main issue to keep in mind is the fine print, as well as making sure the deal is right for you. Here are some other positive aspects of home equity loans:
* Nothing is set in stone until you sign the contract. Rates are flexible, the market is competitive and many lenders are willing to offer you great deals. When the house is the collateral, the lender has very little to worry about. For this reason, interest rates are generally quite low on these loans and can be found in either fixed or adjustable forms.
* You get a lump sum of money! Home equity loans can provide you with a large amount of money. This lump sum can be especially helpful in times of need, such as when you lose your job or have to pay an unforeseen bill. Up to 80% of your home's market value minus whatever you owe on the house can be borrowed in a home equity loan.
* You save on taxes. Interest that you pay on your home equity loan can be used as a tax write-off to help save you money.
The Cons of a Home Equity Loan
While the pros seem attractive, home equity loans also come with some disadvantages. Anyone interested in this form of a loan should closely evaluate the following cons associated with these loans:
* The security on the loan is your home. If you are unable to keep up with the loan payments, then you could lose your home. Young homeowners are not advised to pursue a home equity loan. Similarly, experts recommend that those without substantial savings, plenty of disposable income and a secure job look elsewhere.
* Beware of bad lenders. Always read the fine print or have a lawyer read it over for you to make sure you stay safe. Because hidden fees and terms can be written into the deal, take the necessary time to make sure that the deal offered is right for you.
* Fees can be overwhelming. Home equity loans do carry many different forms of fees on top of the standard rate. Although they can be lowered when drawing up the terms of the loan, make sure that you understand the fees and are ready to handle them when they arise.
* You may spend the lump sum of money on frivolous things. Money is both a positive and negative aspect of any home equity loan because those who don't have money want it, and those who have money want more. Ask yourself this question: Will you really be happy with how much you will be getting out of the loan? How confident are you that you are not going to overspend what you borrowed and get yourself further into debt?
When it comes time to make the decision on whether or not a home equity loan is right for you, be sure to examine all of the positives and negatives associated with this type of loan. Jumping into a home equity loan too quickly can prove to be very destructive, especially if it causes you to lose your house.
Commonly Asked Questions
The following are some questions that borrowers commonly ask.
1. I have bad credit! What do I do?
Don't worry! While people with bad credit may not be able to get the same kind of deal as someone with better credit, home equity loans are open to everybody. This secured loan makes it easy for anyone (no matter their credit) to obtain a home equity loan. In fact, a home equity loan can be used to improve your bad credit, as long as you make your payments on time.
2. How do I avoid getting cheated?
Like anything in life, thinking things through will help you to avoid being cheated by bad lenders. Take time to evaluate all of your options and have a lawyer look over the terms for you. Don't jump in right away and hope everything will be all right. A home equity loan is a major step with a lot at risk, so keep that in mind.
3. What about refinancing the loan?
Refinancing is an option offered by many lenders. Feel free to use your second mortgage in order to refinance your first one. Obviously, this could also lead to worse problems down the road if you aren't careful. Our Mortgage Refinancing Calculator will help you decide if it’s a good time for you to refinance your home.
