Questions and Answers About Home Equity
There are several ways to finance a big home improvement project.
One is to refinance for cash out, the other is to apply for a home equity loan or credit. Here is what you need to know:
What is Equity?
Home equity is the portion of your mortgage that you have paid down.
If you have a $250,000 mortgage and you’ve paid $50,000 of it so far, that’s one fifth or 20% of your home.
This is known as the loan-to-value ratio.
How do I know if I have home equity?
To calculate your home equity, you can use the following formula:
Home equity = Current market value of your home – Amount you still owe on your mortgage
Another way to check your home equity is to look at your mortgage statement and find the LTV ratio (loan to value ratio). It’s usually expressed as a percentage, and it’s the amount of the mortgage balance divided by the home’s value.
You can also use online tools or consult with a professional appraiser to get an estimate of your home’s current value.
Keep in mind that home equity can fluctuate based on changes in the value of the property or changes in the mortgage balance.
What types of Home Equity Loan products are available?
There are two types of home equity loan products available.
- A cash out refinance is a fixed dollar amount that you borrow outright.
- The second is a Home Equity Line of Credit or HELOC.
The HELOC allows you to withdraw small amounts of cash as needed from a fixed amount paying interest only on the amount of money you’ve used.
Home equity loan vs. refinance
The main difference between a home equity loan vs. refinance is a home equity loan is a loan in which the borrower uses the equity in their home as collateral. The loan amount is determined by the value of the property and the amount of equity the borrower has in it.
A refinance is when a borrower replaces their current mortgage with a new one, usually at a lower interest rate.
This can be done to lower monthly payments or to take cash out of the equity in the home.
Is a HELOC considered a second mortgage?
Yes, a Home Equity Line of Credit (HELOC) is typically considered a second mortgage.
A second mortgage is a loan that is taken out using the equity in a property as collateral, in addition to any existing first mortgage that may be on the property.
A HELOC works by using the equity in your home as collateral for a revolving line of credit, allowing you to withdraw small amounts of cash as needed.
Like a first mortgage, a HELOC is recorded as a lien on the property and must be paid back in addition to the first mortgage.
When should I consider a cash out refinance versus a HELOC?
A cash-out refinance is a good option if you need a large sum of money.
It works by refinancing your current mortgage for a larger amount and taking the difference in cash. This can be a good way to access the equity in your home and use it for a specific purpose, but keep in mind that it will also increase the total amount you owe on your mortgage.
On the other hand, a HELOC is a good option if you need access to a line of credit that you can draw on as needed. It works by using the equity in your home as collateral for a revolving line of credit.
This can be a good way to access the equity in your home and use it for various purposes, but keep in mind that interest rates on HELOCs are typically variable, so your monthly payments can change.
Ultimately, choosing between a cash-out refinance and a HELOC will depend on your individual needs and financial situation. It’s always a good idea to consult a financial advisor or a mortgage professional to determine which option is best for you.
What interest rate can I expect to pay on an Equity Loan or Line of Credit?
First off, you can expect to find a better interest rate than you would on a credit card or other unsecured personal loan.
Remember that a cash out refinance and a HELOC are both considered second mortgages and, as such, are available at either a fixed or adjustable rate.
Will I be expected to pay closing costs for equity home loans?
HELOC loans generally do not have closing costs, but may have an application fee.
How should I choose between these two products?
As both are home mortgages, they share one similar advantage. The interest on either may be tax deductible.
Check with your tax advisor to be sure.
Are there disadvantages to a home equity line of credit?
Again, these types of loans are considered a second mortgage, they can be foreclosed on should you default on your payments.
If you do so, your primary mortgage would be paid from the proceeds of the sale of your home by the bank.
Your Home Equity Loan or HELOC would be paid second.