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Home equity loan: Using equity as long term financing option
If you wish to tap the equity in your home and use it to your advantage, you may consider taking a home equity loan. Whether you'd like to consolidate debts, pay for home repairs, make a big purchase or finance your child's education, an equity loan may be the right choice for you.What is a home equity loan?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.
How do you qualify?There are 3 factors that lenders look for in a home equity loan application. The factors given below are:
What rates and terms are available?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. How much can you borrow?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. What do you need to pay?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.
What are the tax benefits?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. Cashing out equity with a fixed rate equity loan makes sense when you stay in the property for a long time. However, for a short term, say, 3-5 years, a Heloc or line of credit may be a better option. If you have enough equity, you may as well as look into the possibility of a cash-out refinance. You may use the cash-out refinance vs 2nd mortgage calculator (given below) to find out which will be better for you. Another option used to leverage equity is the reverse mortgage but that'll be available only if you are aged 62 and above. Related Articles
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