What is home equity loan?

What is a Home Equity Loan?

Home equity loans can also be referred to as home equity installment loans, second mortgages, or HELOAN. A home equity loan is a kind of consumer debt that gives room for you as a homeowner to borrow against the equity of your home. This will then be paid over some time. 

How Does Home Equity Loan Work? 

Equity simply means the value of property minus liens or other encumbrances. This means that the equity of your home is the value of your home minus your mortgage. Depending on the home equity loan lender, you can get up to 80%-90% of your home market value, minus your mortgage.  

This implies;

Amount to borrow = (80%-90% of your home value) – Your mortgage

A simple illustration is, say the value of your home is CA$400,000, you have a mortgage of CA$250,000, and the limit of the home equity lender is 85%. This means you have to calculate 85% of your home value. That will be CA$400,000 multiplied by 0.85 which will equal CA$340,000. Then you will have to subtract your mortgage, CA$340,000 – CA$250,000, which equals CA$90,000.

Suppose these are the values of your home equity and your mortgage, with the lender’s limit, then you can borrow up to $90,000.

With home equity loans, you can get a lump sum of money at once. Then, you’ll be allowed to pay monthly over a specific and fixed period, with a fixed interest rate. The amount you’ll be returning will have the interest rate added. The interest rate and the period you’ll be paying are dependent on the home equity loan lender. 

You should understand that if you default in the payment, your home is at risk. Home equity is akin to having your house being used as collateral. 

Requirements to Get Home Equity Loans

Some things home equity loans lenders will put into consideration before allowing you to get a loan. They are;

Have a good percentage of equity in your home. 

As earlier depicted, equity is the difference between your mortgage and the market value of your home. This is a big factor in deciding if you will be qualifying for a home equity loan. To find out the percentage of your equity, you have to divide your mortgage by the market value of your home, subtract it from 1 and multiply by 100

% of equity = (1 – Mortgage/Home appraised value) × 100

For example, if your mortgage is CA$250,000 and the value of your home is CA$400,000, you will divide your mortgage by the value of your home to get 0.625. Then subtract from 1, which gives 0.375. Finally, multiply by 100 to get 37.5%. 

Make sure you have 15% equity at least, before applying for a home equity loan. To increase the percentage of your home equity, you should pay your mortgage bill. 

A Good Credit Score

Having a good credit score is necessary to qualify for a home equity loan. An individual with a credit score higher than 700 has a high probability of qualifying for a home equity loan. 

A Debt-to-income Ratio Lesser Than 40%

Another requirement is your debt-to-income ratio. Having a lower ratio will increase your chances. The specific ratio is dependent on the home equity lender. So, try maintaining a ratio as low as possible. You can calculate the ratio yourself before applying by dividing your debt by your home gross monthly income, then multiply the result by 100. 

Other requirements that will increase your chances of getting a loan with a good lender with a low-interest rate are:

• Good loan payment history 
• Have enough or sufficient income

Advantages and Disadvantages of Home Equity Loan 

As much as this type of consumer debt has a lot of advantages, it also has several disadvantages that should be put into consideration before making a decision. 

Advantages 

• Home equity loans come with low-interest rates, mostly. The interest rates are always fixed, too. 
• It’s such an easy way to get a good and substantial amount of money, which will be paid over a while. 
• It’s also an advantage that it can be gotten with what you own — the value of your home. 
• You’re going to be paying a fixed amount of money frequently over some time. This makes it easier to pay, knowing how much you have to pay each month. 
• The repayment period is always stretched. It can be between 5-15 years, depending on the lender. 

Disadvantages 

• Your home is at risk if you default in paying the home equity loan lender the fixed amount of money planned per time. 
• A great credit score is needed as the lowest rates are given to borrowers that are qualified with a great credit score. A much as it is true that home equity loans come with low-interest rates, the competition in getting qualified for them is quite high. 
• You must have good home equity. Home equity of at least 15% is required. 
• You might not qualify if your debt-to-income is high and you don’t have a good history of paying back debts. The lender won’t find it easy to give you a home equity loan, as your loan history is on the high side. 
• If the value of your home decreases, you might owe more than the worth of your home. This is popularly known as “upside-down” or “underwater”. 

Conclusion 

Getting a home equity loan may be just what you need to achieve your home goals, or whatever it is that you intend to do. Make sure you can pay at the period agreed before taking up a home equity loan.