Home equity loans allow the person in financial need to borrow a lump sum of money using their home as security. How much you can borrow is determined by several criteria, including the value of the home and the amount still owing on the mortgage.
How does a home equity loan work?
Home equity loans allow the person in financial need to borrow a lump sum of money using their home as security. How much you can borrow is determined by several criteria, including the value of the home, the amount still owing on the mortgage, the applicant's income and credit history, and each lender's appetite for risk.
What is a home equity loan?
A home equity loan is a sort of consumer debt that is also known as an equity loan, home equity instalment loan, or second mortgage. Home equity loans enable homeowners to borrow against the value of their houses. The loan amount is determined by the difference between the current market value of the house and the homeowner's mortgage debt owing. Home equity loans are typically fixed-rate, whereas home equity lines of credit (HELOCs) are often variable-rate.
A home equity loan can be an excellent method to turn the equity in your house into cash, especially if you use that cash to make home improvements that boost the value of your property.
If you have more than 20% equity in your house and a credit score of at least 680, you may be eligible for a home equity loan. This lets you borrow money for five to ten years at a low fixed interest rate while using your house as collateral.
As a homeowner, you accumulate equity in your house over time as you pay down your mortgage and the value of your property increases. It's worth understanding how this process works before you decide whether a home equity loan suits your situation. If you're also thinking about selling and buying at the same time, you might find it useful to read about what a relocation loan and bridging finance can offer as an alternative approach.
How does a home equity loan work in practice?
A home equity loan, a type of second mortgage, allows you to borrow against the value of your property. It functions similarly to a first mortgage, but with slightly higher interest rates. You borrow a lump sum and make similar monthly principal and interest payments over the following five to ten years, depending on the loan period you pick. Because your house serves as security for the loan, the lender takes on less risk and can offer a lower rate than unsecured borrowing.
How to calculate my home equity value?
The first step in determining if a home equity loan is good for you is determining how much equity you have in your property. This will give you an indication of whether you're eligible and how much you could borrow.
The difference between your house's appraised worth and your mortgage debt is your home equity. If your house is worth $450,000 and you owe $225,000 on it, your equity is 50%. If you have entirely paid off your mortgage, your equity is 100 percent.
A combined loan-to-value (CLTV) ratio must be calculated to see how much you would be able to borrow with a home equity loan. Most home equity lenders offer a CLTV ratio of at least 80% on your primary residence. Regions Bank allows up to 85%, Discover up to 90%, and Spring EQ up to 97.5 percent.
Let's imagine your house is valued at $450,000 and you have a $225,000 first mortgage. Divide $450,000 by 0.8 to see how much debt most lenders will allow against your home: $450,000 x 0.8 equals $360,000. Then deduct $225,000: $360,000 - $225,000 = $135,000. That's the maximum amount you may borrow.
Is home equity loan interest tax deductible?
You may be allowed to deduct the interest you pay on a home equity loan if you use the funds to buy, develop, or significantly improve the property that secures the loan. Many consumers won't save much from the mortgage interest tax deduction, but it's a question worth asking your tax adviser before you commit.
The short answer is yes. When filing your income tax return, you can deduct the interest paid on your home loan in qualifying circumstances.
If you want to borrow a lump sum at a fixed interest rate, repay it with predictable monthly payments over five to ten years, and are comfortable taking on additional debt secured by your house, a home equity loan may suit you. A HELOC may be a better option if you need to borrow smaller amounts on an as-needed basis. If you don't want to take on extra debt with your house as collateral, a low-interest credit card may be the way to go. You must, however, be prepared to handle the monthly payment fluctuations generated by variable interest rates.
Speak to our expert mortgage broker today to learn more about your eligibility for a home equity loan or a home equity line of credit.