If you are thinking about undertaking a major home improvement project or debt consolidation for those mounting credit card bills, then perhaps it’s time to consider a home equity loan. While the two most common home equity loans are the home equity loan and the home equity line of credit (HELOC), there are a couple of other mortgage loan options as well including the 125% loan and cash-out refinancing. When comparing home equity loans several factors should be considered such as whether it’s a fixed or variable interest rate, if you have good or bad credit, which affects the interest rate of the loan, how much equity you have in your home and how much money you need and for what purpose, and which loan offers monthly payments you can afford.
What is a Home Equity Loan?
A home equity loan allows a homeowner to obtain cash in the form of a loan or line of credit in return for the equity built up in their home. Equity refers to the difference between the original loan amount on the mortgage and what the home is currently worth. For example if a home with an original mortgage loan of $100,000 is now worth $150,000 the amount of equity in the home is equivalent to $50,000.
Homeowners can benefit from second mortgages in several ways. Home equity loans generally have a lower interest rate than other types of loans and since most homeowners already have some equity built into their homes, they are a convenient and easy source of cash. There are also tax advantages in that the interest is tax deductible unlike credit card or loan interest.
What Kinds of Home Equity Loans are Available?
A home equity line of credit (HELOC) or home line of credit is a variable rate loan. Monthly payments vary according to the interest rate, which corresponds to the prime rate set by the Federal Reserve Bank. With a HELOC, homeowners are pre-approved for a specific amount of money and use the loan like a line of credit, withdrawing cash as it is needed. Interest rates (and monthly payments) often start off low but eventually end up rising.
In contrast, a home equity loan offers homeowners a lump sum payment with a fixed interest rate and loan terms ranging from 5 to 15 years. Homeowners pay the same amount of money every month for the duration of the loan. Both are considered second mortgages, and as with a conventional mortgage loan, both home equity loans and home equity lines of credit have closing costs associated with them. According to Don Taylor, PhD, CFA, CFP, a columnist at Bankrate.com, if you need money for a big-ticket item or single home improvement project go with a home equity loan. If you need money on a continuous basis and don’t mind the fluctuating interest rates, go with a HELOC.
The 125% loan is a 2nd mortgage loan option in which homeowners can borrow up to 125% of home’s value. For example, if your home is worth $100,000 and your first mortgage is $95,000, you can borrow $30,000, for a total of $125,000. The total of the first and second mortgages combined cannot exceed the appraised value of the home however. A 125% loan is useful when a homeowner needs more cash than can be obtained through a conventional home equity loan. Cash-out refinancing refers to refinancing your home at a lower interest rate (either a fixed or variable rate) and getting cash out, providing cash to a homeowner to pay for home improvement projects or pay down credit card bills.