Home equity loan: Using equity as long term financing option

Equity loan is a fixed rate second mortgage offered against your home equity which is the collateral here. Since payments are almost fixed, therefore, you can plan your budget accordingly. However, you may also find equity loans with variable rates and payments.

There are 3 factors that lenders look for in a home equity loan application. The factors given below are:

• Credit History:
You need to have a decent credit record along with a credit score of 680 and above in order to qualify for an equity loan. Getting an equity loan with bad credit is quite tough especially if the mortgage and housing markets are in a crisis.


• Debt to Income Ratio:
Lenders prefer a debt-to-income ratio below 36 percent in order to approve your equity loan.


• Loan to value ratio:
Lenders would like to keep your total loan-to-value ratio (including first mortgage balance and equity loan) equal to or less than 80% of the home value. So, the first mortgage balance is what they'll consider when they provide an equity loan.

Home equity loan rates are usually higher than that of first mortgages but lower than credit cards and unsecured personal loans. The terms usually range from 10 to 30 years depending upon the loan amount.

To know what the equity loan rates are, request for no-obligation free mortgage quote from lenders and then try to compare the costs and total interest you'll have to pay for each type of loan offer. You may use the Mortgage Payment Comparison Calculator (given below) to compare how much you need to pay for each offer.

You can borrow an amount such that the second mortgage and the first loan balance combined together don't exceed 80% of the equity in your home.

Let's take an example:

Say you've bought a home worth $220,000 and paid $20,000 as the down payment. You've taken a mortgage worth $200,000 on your property. The equity at the time of purchase is equal to the down payment, that is, $20,000.

Let's say after 5 years, your home value has accelerated to $300,000 and you've paid down $15,000 of the principal loan amount. So, you still owe = $200, 000 - $15,000 = $185, 000.

Your equity in the home is then = (Current appraised value – amount you owe) = $300,000 - $185, 000 = $115,000

Now say, if you wish to borrow $50,000 from your equity. Then the combined mortgage balance is = $185000 + 50000 = $235000, less than 80% of your current home value (that is, $240,000). So, the combined LTV is well within 80% of the current appraised value of your home.

However, there are lenders who may offer a loan equal to 125% of the home value. But for that you need to pay higher fees and rates of interest compared to what you'll pay for a traditional home equity loan.

You need to pay the closing costs which are almost similar to the costs in a second mortgage. Some of the costs include that of property appraisal, loan application, title search etc. Of course the biggest cost that you'll have to pay is the interest on the loan. You may or may not have to pay the PMI.

The interest on a home equity loan is deductible but only if you itemize your deductions. Know more on how to deduct interest on your taxes.