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Home equity loans can be a great way to tap into the value of your home, but with so many options available, it can be overwhelming to decide which one is right for you.
There are several types of home equity loans to consider.
A home equity line of credit (HELOC) is a type of revolving credit that allows you to borrow and repay funds as needed. You can access funds through checks, credit cards, or online banking.
A fixed-rate home equity loan provides a lump sum of money upfront, with a fixed interest rate and repayment terms. This can be a good option if you need a large sum of money for a specific purpose.
A home equity loan can be used for various purposes, such as paying off high-interest debt, financing home improvements, or covering unexpected expenses.
What Is
A home equity loan is a type of loan that allows homeowners to borrow money using the equity in their home as collateral.
Home equity loans can be either fixed-rate or variable-rate loans, with fixed-rate loans offering stable monthly payments and variable-rate loans offering lower interest rates but with the risk of higher payments if interest rates rise.
There are two main types of home equity loans: lump sum and line of credit. A lump sum loan provides a single payment upfront, while a line of credit allows borrowers to draw funds as needed.
Home equity loans can be used for a variety of purposes, including home renovations, debt consolidation, and major purchases.
Types of Home Equity Loans
Home equity loans come in various forms, each with its own benefits and drawbacks. A home equity line of credit (HELOC) is a revolving credit line that lets you borrow and repay funds as needed, with a variable interest rate and a 10-year draw period.
A HELOC is ideal for borrowers who need access to funds on an ongoing basis or have intermittent financial needs, such as home renovations or tuition payments. It's also suitable for those who can afford an extra monthly payment.
Here's a comparison of the main types of home equity loans:
These loan types offer different benefits and requirements, and it's essential to choose the one that suits your financial situation and needs.
HELOC: Overview
A HELOC, or home equity line of credit, is a type of revolving credit that lets you borrow and repay funds as needed.
The available balance on a HELOC is typically higher than a credit card, and the interest rates are lower, but it still requires underwriting like a mortgage.
A HELOC has an initial draw period that can last up to 10 years, during which you can take out funds and make interest-only payments.
Once the draw period ends, there's a repayment period that can last 10 to 20 more years, during which you'll repay both interest and principal.
The interest rate on a HELOC can fluctuate, which means it could rise, so you'll need to be able to handle that.
A HELOC can be a good option if you have intermittent financial needs, such as a series of smaller renovations or periodic tuition payments.
You can have a HELOC in addition to your current mortgage, but that means you'll need to make an extra monthly payment.
Fixed Rate vs Variable Rate
Fixed rate home equity loans offer a predictable monthly payment that remains the same, making it easier to budget.
With a fixed rate loan, you can expect the interest rate to remain the same throughout the life of the loan, even if market rates fluctuate.
Variable interest rates, on the other hand, can change based on the market index used for the loan, which means your monthly payments could increase or decrease over time.
Your credit score and debt-to-income ratio can affect the initial interest rate you're offered on a variable rate loan, with higher scores and lower ratios often resulting in better rates.
Variable rates can work in your favor when interest rates are low, but may increase your costs if rates rise.
You can view current home equity loan rates to better understand what rates you could expect, or use a monthly payment calculator to see what your payments might look like for a fixed rate home equity loan.
A fixed rate home equity loan can be a good option if you want predictable monthly payments and can afford an additional mortgage payment each month.
Heloc vs. Cash-Out Refinance
A HELOC (Home Equity Line of Credit) and a cash-out refinance are two popular options for tapping into your home's equity. Borrowers who want access to funds on an ongoing basis or need an undetermined amount tend to prefer a HELOC.
A HELOC has a credit line with a variable interest rate, which can be a plus for those who want flexibility. However, it also means your payments could increase over time. Borrowers who want fixed payments and know how much they need, on the other hand, might prefer a cash-out refinance.
Here's a key difference between the two: a HELOC typically requires a lower equity percentage, ranging from 10-20%, while a cash-out refinance requires 20% equity or more, unless you're willing to pay mortgage insurance.
If you choose a HELOC, you can expect to pay interest only during the draw period, followed by interest and principal payments. A cash-out refinance, by contrast, requires principal and interest payments from the start.
In terms of closing costs and fees, a HELOC is generally comparable to but lower than a home equity loan, with annual and early termination fees to consider. A cash-out refinance, however, comes with closing costs that are a percentage of the principal amount, typically ranging from 2-5%.
Cash-Out Refinance
A cash-out refinance is a type of home equity loan that can be a good option if you need cash and want to change your mortgage terms at the same time. You can get a lump sum of cash when the new loan closes, and it's essentially a mortgage with benefits.
You'll need to have at least 15% equity in your home to qualify for a cash-out refinance, although some lenders may go as high as 95%. Credit score requirements are also strict, with a minimum of 580, and a debt-to-income ratio of under 50%.
A cash-out refinance can have a fixed or variable interest rate, and the term can last anywhere from 5 to 30 years. However, be aware that closing costs are higher for a cash-out refinance, not because the percentage is higher, but because the loan amount is larger.
Here are some key differences between a cash-out refinance and other home equity loan options:
Ultimately, a cash-out refinance is a more elaborate and expensive process than other home equity loan options, but it offers financing at a substantially lower interest rate.
Types of Home Equity Loans
There are two main types of home equity loans: fixed rate and variable rate.
A fixed rate home equity loan has a consistent interest rate that won't change over time, making it easier to budget your monthly payments.
With a variable rate home equity loan, the interest rate can fluctuate with the market, which means your monthly payments could increase or decrease.
Home equity lines of credit (HELOCs) often come with variable interest rates that are based on a publicly available index, such as the prime rate or U.S. Treasury bill rate.
Your credit score and debt-to-income ratio can affect the initial interest rate you're offered on a HELOC, with higher credit scores and lower debt-to-income ratios often resulting in better interest rates.
The length and amount of your loan can also impact your interest rates, with shorter-term loans and lower loan amounts typically resulting in lower interest rates.
HELOCs have a variable interest rate and an initial draw period that can last up to 10 years, during which you can take out funds and make interest-only payments.
Understanding Home Equity Loan Terms
Home equity loans come in a range of term lengths, typically between 10 and 30 years, with the difference in monthly payments and overall cost of financing being a key consideration.
The length of the loan can significantly impact your monthly payments, with a 10-year loan likely having much higher payments than a 20-year loan. However, the total interest paid over the life of the loan can be higher with a longer repayment term.
To illustrate the difference, consider a $50,000 home equity loan at 10% interest: a 10-year repayment term would cost $660.75 each month, while a 30-year repayment schedule would cost only $438.79 each month, but with a total payment of $157,962.88.
Here's a breakdown of the typical term lengths and their corresponding monthly payments:
Typical Terms
Home equity loans typically come with terms between 10 and 30 years, which can significantly impact your monthly payments and overall cost of financing.
The features of the loan can be similar regardless of the length, but the difference comes in with monthly payments and the overall cost of financing as longer-term loans may have a higher annual percentage rate (APR).
If you borrow $50,000 at 10% interest, a 10-year repayment term will cost you $660.75 each month for total payments of $79,290.44 for the life of the loan.
Longer repayment schedules, like a 30-year repayment term, can lower your monthly payments, but you'll pay more interest over time, resulting in a higher total cost of the loan.
Payment Example Disclosure
If you borrowed $60,000 for a 20-year term at 8.86% APR, your fixed monthly payments would be $534.45.
Your monthly payments will depend on the loan amount, term, and interest rate. For example, if you borrow $60,000, your payments will be significantly higher than if you borrowed $30,000.
Discover Bank offers home loans, and their APRs can range from 8.86% to unknown rates for other loan products. You can use their Loan Amount Calculator to see how much you can borrow based on your home's value and your credit score.
To calculate your fixed monthly payments, you'll need to know the loan amount, term, and interest rate. You can use online calculators or consult with a lender to get an estimate.
Here are some examples of loan amounts and corresponding monthly payments:
Keep in mind that these are just examples, and your actual monthly payments may vary depending on your individual circumstances. It's always a good idea to consult with a lender or financial advisor to get a more accurate estimate.
Calculating Your Balance
To calculate your home equity, you need to know your outstanding mortgage balance and your home's value. For example, if your outstanding mortgage balance is $150,000 and your home is valued at $450,000, you have $300,000 of equity.
You can also express your home equity as a percentage of your home's worth. To do this, divide your equity by your home's value, then multiply by 100. In the above example, you'd have almost 67 percent equity in your home.
Most lenders require that you have a certain percentage of equity in your home before you can start tapping it. This percentage is typically between 15 percent to 20 percent. If your lender requires 20 percent equity be left untapped, your loan's balance must be no more than 80 percent of the home's value.
The dollar value of your equity impacts what you can borrow. For instance, if you own a $500,000 home and have a 50 percent equity stake, you can borrow up to $200,000, assuming the lender requires 20 percent equity be left untapped.
Combined Value Ratio
The combined value ratio, also known as the combined loan-to-value (CLTV) ratio, is a crucial factor lenders consider when evaluating your home equity loan application. It calculates how much debt is backed by a property versus its worth.
To calculate the CLTV, add up all your current and prospective loan obligations and divide the total by your home's current appraised value. For example, if you owe $60,000 on your first mortgage and want to open a HELOC with a $15,000 credit line, your home is worth $400,000, and the CLTV is 18.75 percent.
Lenders use the CLTV ratio to determine how much they're willing to lend you. Some lenders, like Discover Home Loans, offer home equity loans with CLTV up to 90% to residents of California. However, it's essential to note that lenders have different CLTV limits, and state-level restrictions may apply.
The CLTV ratio can vary depending on the lender and your specific situation. For instance, if you have a $500,000 home and a 50% equity stake, you'd have $250,000 in equity, but the lender may require you to maintain 20% equity untapped. This means you could borrow up to $200,000.
Here's a simple way to understand the CLTV ratio:
Keep in mind that lenders will offer borrowing up to a certain CLTV limit, and it's essential to understand what that limit is for your specific situation.
Home Equity Tax Implications
Home equity loans, HELOCs, and cash-out refis don't incur taxes because they're considered debt, not income.
These types of loans even carry some tax benefits, but only under certain conditions. You must use the loan money to buy, build, or substantially improve your home.
You can deduct the interest you pay on home equity loans and HELOCs if you itemize deductions on your tax return.
Joint and single filers can deduct interest on up to $750,000 of qualified loans, while married, filing separately taxpayers are capped at $375,000.
These thresholds apply collectively to all your home-based debt, so if you have a mortgage and a home equity loan, the combined amount can't exceed $750,000 for deductibility.
With a cash-out refinance, the interest on the portion of the loan that replaces your mortgage is tax-deductible, just like your old loan was.
Home Equity Loan Options
Home equity loan options can be a bit overwhelming, but let's break it down. A home equity loan is a second mortgage that lets you borrow a lump sum of money, usually with a fixed interest rate.
You'll need to own at least 15% equity in your home, although some lenders will go as high as 95%. Credit scores of 620 or higher are usually a minimum requirement, but some lenders may consider borrowers with scores as low as 580.
A home equity loan typically has a fixed interest rate and a repayment term of 5 to 30 years, with 30-year mortgages being the most popular. Closing costs are usually 2-5% of the principal amount.
Here are the key features of a home equity loan at a glance:
- Fixed interest rate
- Repayment term: 5-30 years
- Closing costs: 2-5% of principal
- Equity requirement: 15-20%
When to Choose a Cash-Out Refinance
If you want to improve your mortgage terms, a cash-out refinance is a great option. You can get a better interest rate if rates have declined since you initiated your mortgage, and you can also extend or shorten the timespan of your mortgage.
You like to keep it simple, and a cash-out refinance offers that. With one loan, you're repaying both your original mortgage and the cash-out amount simultaneously, eliminating the need for separate home equity loan payments.
You need stability in your budget, and a cash-out refinance provides that. Unlike home equity loans, which can have varying monthly payments, a cash-out refinance offers long-term, fixed-rate financing.
Cash-out refinances are particularly appealing now, as they often come with lower interest rates compared to home equity loans or HELOCs, and they consolidate debt into one payment. However, higher closing costs and a potentially extended loan term are considerations.
If you need cash right now and want to change your mortgage terms anyway, a cash-out refinance is a good choice. It replaces your mortgage with a new one, giving you a lump sum of cash and a potentially better interest rate.
Here are some key factors to consider when choosing a cash-out refinance:
Find Affordable Lenders
Finding the right lender for your home equity loan or HELOC can be overwhelming, but it's essential to consider the fees associated with your loan. In California, you can find lenders with affordable fees by comparing the costs.
A good starting point is to look for lenders that don't charge application fees, origination fees, appraisal fees, or closing costs. Discover is one such lender that offers $0 application fees, $0 origination fees, $0 appraisal fees, and $0 costs at closing.
Comparing home equity loan rates and HELOC rates in California can also help you find a lender with the best rates. A lower credit score can often result in a higher interest rate, so it's essential to check your credit rating before applying.
In California, home equity loan interest rates may be lower if you repay the loan within five years, but the interest rate range will increase if you spread the loan out for a longer repayment term. HELOC interest rates, on the other hand, are often variable and depend on the national bank rate.
Frequently Asked Questions
What is the monthly payment on a $50,000 home equity loan?
The monthly payment on a $50,000 home equity loan can range from $489 to $620, depending on creditworthiness. However, having a good credit score and history is crucial to qualify for the best rates and terms.
What is the monthly payment on a $100,000 home equity loan?
The monthly payment on a $100,000 home equity loan varies depending on the loan term and interest rate, but here are two examples: $1,239.86 per month for a 10-year fixed loan at 8.50%, and $979.47 per month for a 15-year fixed loan at 8.41%.
How is a $50,000 home equity loan different from a $50,000 home equity line of credit?
A $50,000 home equity loan provides a lump sum upfront, while a $50,000 home equity line of credit (HELOC) offers flexible access to funds as needed. This difference affects how you borrow and repay the money.
What is the monthly payment on a $50,000 HELOC?
For a $50,000 HELOC, monthly payments are approximately $384 for interest-only or $457 for principle-and-interest. The actual payment may vary based on interest rates and loan terms.
Sources
- https://www.discover.com/home-loans/articles/different-types-of-home-equity-loans/
- https://point.com/blog/types-of-home-equity-loans
- https://www.usbank.com/home-loans/home-equity/compare-home-equity-options.html
- https://www.bankrate.com/home-equity/home-equity-loan-heloc-or-cash-out-refi/
- https://www.discover.com/home-loans/articles/home-equity-loans-california/
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