HOME EQUITY IS…
Home equity is the appraised value of your home minus any outstanding mortgage and loan balances. Simply, it is the portion of your home that you have paid. For many, it is also a homeowner’s most valuable asset. Additionally, home equity increases without you having to do anything more than pay your regular mortgage payments. Home equity builds over time as you pay down mortgage balances, as the value of your home increases due to renovations, or inflation. Equity in your home is an important asset for homeowners since it can be used to borrow a Home Equity Line of Credit (HELOC).
Whether you want to renovate or consolidate debt, borrowing against the equity could be a good option depending on your situation. Home loans have many similarities, but with important differences.
WHY IS HOME EQUITY IMPORTANT?
Home equity is important because it can be part of your long-term strategy for building wealth. Mortgage payments reduce what you owe while your home gains value. Basically, making payments on your home becomes a forced savings account where you can become equity rich. With the equity, you can apply for loans.
WHAT ARE THE DIFFERENCES BETWEEN HOME LOANS?
To purchase a residence, you would need a mortgage loan. Many financial institutions lend about 80% of the home’s appraised value or the purchase price, whichever is less. For example, a house is appraised at 1 million and you would be eligible to borrow as much as $800,000. You would have to pay the remaining 20% or $200,000.
Additionally, lenders typically lend based on the appraised value of the home. For example, the house is appraised for $800,000 and it’s selling for 1 million. Typically, the lender will approve 80% to 100% of the $800,000. You would have to pay the remaining $200,000 plus the remaining percentage of the appraised value.
The interest rate can be a fixed rate (the same throughout the term of the mortgage) or a variable rate (changing every year). The borrower repays the amount of the loan plus interest over a fixed term. The most common terms are between 15 to 30 years.
A Home Equity Loan is based on the equity that is available in the property, which is the difference between the property’s value and the existing mortgage balance. If your remaining mortgage loan is $500,000 and your property is valued at $1,000,000, for example, you have $500,000 in equity. Assuming your credit is good and you otherwise qualify, you can take out an additional loan using $500,000 as collateral.
A Home Equity Loan is an installment loan repaid over a fixed term. Different lenders have different standards as to what percentage of a home’s equity they are willing to lend, and the borrower’s credit rating helps to make this decision.
HOME EQUITY LINES-OF-CREDIT (HELOC)
A Home Equity Line-of-Credit, known as a HELOC, gives you a revolving credit line to use for large expenses or to consolidate high-interest debt. A HELOC often has a lower interest rate than other types of loans.
Like a Home Equity Loan, you are borrowing against the available equity. As you repay the outstanding balance, the amount of available credit is replenished – much like a credit card. This means you can borrow against it again if you need to and you can borrow as little or as much as you need throughout your draw period up to the approved credit limit. At the end of the draw period, the repayment period begins. Not all Home Equity Lines of Credit are created the same. Some lenders have different draw periods, repayment periods, borrowing limits, and minimum/maximum withdrawal amounts.
WHAT ARE THE SIMILARITIES BETWEEN HOME LOANS?
- Mortgages, Home Equity Loans, and Home Equity Lines of Credit (HELOC) are all loans where the borrower pledges their property as collateral.
- On average, lenders generally allow you to borrow up to 80% of a home’s value.
- Home loans may have tax benefits. Please consult your tax advisor for possible benefits.
TERMS TO KNOW
LOAN-TO-VALUE (LTV) RATIO
Lenders use the loan-to-value (LTV) ratio to determine how much money someone can borrow. LTV is calculated by taking the total amount the borrower still owes on the house and dividing it by the value of the house. If a borrower has paid down a good deal of their mortgage or if the home’s value has risen significantly, the borrower may be able to get a sizable loan.
In many cases, a Home Equity Loan is considered a second mortgage, but not all Home Equity Loans are second mortgages. A borrower who owns his property free and clear may decide to take out a loan against the home’s value. In this case, the lender making the Home Equity Loan will be considered a first-lien holder.
The loan’s interest rate is the same throughout the term of the mortgage.
The loan’s interest rate changes on a schedule (for example, monthly, yearly, or on a specified schedule).
Mortgage points are also known as discount points, which are fees paid directly to the lender at closing in exchange for a reduced interest rate. This is also called buying down the rate, which can help you lower your monthly mortgage payments and pay less interest over time.
One point equals 1 percent of your mortgage amount (or $1,000 for every $100,000). In general, the longer you plan to own the home, paying down more points help you save on interest over the life of the loan.
Closing costs are fees and expenses you pay when you close on your house beyond the down payment. These costs may include title insurance, attorney fees, appraisals, taxes, inspections, and more.