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Got Equity? When and How to Make Use of Your Equity

Got Equity? When and How to Make Use of Your Equity

The most important thing to understand about a home equity loan is that a default on the loan means you will lose your home and be forced out of it. Hence, if you do take advantage of your equity, do it wisely and for good reason. Here are some tips to help you understand home equity loans and lines, and if they are right for you.

Home Equity Loans: What to Expect

Equity is the amount you get after subtracting your mortgage balance from your home’s current fair market value. In other words, home equity is the figure that represents how much of that property you own. There are a few ways of accessing your home equity, but one of the most common and less risky ones is through a home equity loan.

Just like its name suggests, a home equity loan is a type of installment debt that allows you to borrow against your equity. With this type of loan, you borrow a certain amount at a fixed rate, which is then disbursed on a single-lump sum and is repaid through a series of regular monthly payments for a set period of time, also known as the “term.”

Keep in mind most financial institutions will only allow you to borrow 80% – 90 % of the value of your home. For example, let’s say the value of your home is $300,000. Now 80% of that is $240,000. If you still owe $220,000 on your 1st mortgage, then most likely you will only be able to borrow $20,000 on your equity ($240,000 – $220,000 = $20,000).

If you have exceptionally good credit, then you may be able to borrow up to 90% of the value depending on which financial institution you’re dealing with, in which case you’ll be able to borrow $50,000. ($300,000 value X 90% = $270,000 – $220,000 1st mortgage = $50,000).

Benefits of a Home Equity Loan

One of the main benefits of taking out a home equity loan is that you can use the funds however you want. Also, since you’re using your home as collateral, interest rates tend to be much lower than those of unsecured debt, like personal loans and credit cards.

In addition, some or all, of the interest accrued on a home equity loan may be deducted from your taxable income.

Some of the best uses for home equity loans include:

  • Consolidate High-Interest Debt
  • Home Renovations
  • Refinance Another Loan
  • Investing
  • Pay for Higher Education Expenses
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Where Can You Get Them?

You can apply for a home equity loan through multiple channels, all of which have their pros and cons regarding the type of assistance they offer, fees, discounts, terms, and interest rates.

  • Banks
  • Credit Unions
  • Online Lenders

When you apply for a home equity loan, there are five things lenders usually look at: your combined loan-to-value ratio (CLTV), debt-to-income ratio (DTI), credit score, available equity and proof of income.

Aside from checking your CLTV, DTI, available equity and credit score, there are a few other things experts recommend you do, prior to applying for a home equity loan, such as:

  • Getting an appraisal
  • Having everything in writing
  • Not opening or closing any accounts just before applying for a loan.
  • Even once you’re approved for a loan, DO NOT apply for any type of credit until after your home equity loan has closed and funded.

Any lender will most likely run your credit again after approval and prior to funding to ensure nothing on your credit report has changed. For example, if you purchase a new car prior to the funding of your loan, you may run the risk of getting your home equity loan denied towards the end of the process.

Final Thoughts

In general, home equity loans have a much lower interest rate on it than any other type of personal loan. If the homeowner can handle the monthly payments, the financial advantages that the second mortgage gives are truthfully unmatched. The terms on a home equity loan are also very flexible ranging from 5-30 years at a fixed interest rate.

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