Twenty years ago, when I was first out of college, I had a job as a loan originator for a home equity financing company. All day long, I completed loans for people from all walks of life.
My employer’s marketing materials promoted the idea of tapping into quickly growing home values for home improvements, debt consolidation, car purchases, college education and dream vacations. Consumers gobbled up these loans. Some used the funds for needs and some got in over their heads by using the funds for wants. It was the fat days of 1990′s and having more was easy.
Well, times have changed and utilizing credit in a careful manner in en vogue. Home equity loans are still available and a viable option for some home owners, so it’s time for a crash coarse in Home Equity Financing.
Two Types Of Home Equity Financing
There are 2 types of home equity financing: Loans and Lines. Both use the equity in the home and both create a second mortgage on your home. Lenders will generally require a maximum loan to value (LTV) of 80%, which means the total of your first mortgage balance and the home equity loan/line that you are applying for may not exceed 80% of the appraised valye of your home.
Home Equity Loans – The word “loan” implies that it’s an installment loan, similar in type to that of a car loan. You’ll borrow the money in one lump sum and make equal monthly installments of principal and interest to repay the debt. Once the loan is paid off, the mortgage will be discharged (eliminated).
Usually, this loan carries a fixed rate of interest, no annual fee and has minimal costs (appraisal, title search fees) at closing. This is the loan you choose if you know exactly how the money will be used and the dollar amount. Because it’s a second mortgage, the interest rate is usually slightly higher that that of a first mortgage loan.
Home Equity Lines – The word “line” implies that it’s a line of credit, similar to a credit card. The lender approves you for a maximum credit allowance and provides you with a book of checks that can be written against your line. Some may even provide you with a credit card which is tied to the line.
You may borrow up on the line and pay down as you see fit. Minimum monthly payments are usually 3-5% of the balance plus interest. The interest rate charged varies usually a certain percent over prime. Fees may include usage charges, non-usage charges, annual fees and others. Because it requires you, the borrower, to be very disciplined, the interest rate is usually higher than that of a home equity loan, but because it’s secured, it’ll be lower that a credit card.
Home Equity Financing – Weighing the Pros and Cons
It’s so important that you carefully consider how you use your home equity financing, weighing the pros and cons. Borrowing against your home puts your home at risk, so it’s best to use home equity financing for NEEDS, not wants. Home improvements are needs, vacations are wants.
Currently, cars can be purchased with very low rates, secured by the vehicle and leaving your home equity unencumbered. Student loans also have low rates and don’t require repayment until the student is out of school.
Finally, debt consolidation may be your only way to get out of the credit hole you may be in, just be sure that if you’re using your home equity financing for this purpose that you stop using your credit cards entirely…a sharp pair of scissors just may be your best friend.