Home equity loans are also known as second mortgages. You are borrowing the equity you have built up through years of first mortgage payments to spend for other purposes. There are definite benefits to getting a home equity loan, provided you understand and avoid the pitfalls.
Good Reasons for Getting a Home Equity Loan
Home improvement projects are a popular reason people apply for a home equity loan. The homeowner and the lender benefit since the house will have greater value after being updated and remodeled.
Some people apply for a home loan to pay off their high-interest credit cards. Debt consolidation can be a good thing: interest on home loans is lower than credit card interest, and the interest is usually deductible, whereas finance charges on credit cards and car loans are not deductible.
Bad Reasons to Apply for a Home Equity Loan
If you plan to sell the house and relocate in the near future, then a home equity loan is probably not the best decision. You would not have enough time to recoup the closing costs and would most likely have to pay an early-termination penalty to the lender. Additionally, your credit might be maxed out and adversely affect your chance of getting a mortgage on a home in your new community.
If you are having financial difficulties due to insufficient income, then seriously consider whether a home equity loan will solve the long term problem. Sometimes it does, especially if your career is upwardly mobile. If you do not see advancement in the near future, however, it might be too difficult to pay two mortgages every month.
How Much Can You Borrow?
Home equity loans cannot exceed a certain percent of your home's current value, depending on the state in which the property is located and the lender's underwriting guidelines. Some are more lenient than others. The bank or mortgage company will conduct a home appraisal and add it to the closing costs.
How Much Are Closing Costs?
Closing costs on home equity loans are similar to those of first mortgages. Since your home will secure the loan, the lender must be certain you are credit-worthy and that your home has sufficient value. The main difference is not having to create an escrow account to pay property taxes and insurance.
Some lenders deduct closing costs from the cash proceeds, while others demand a cashier's check at closing. Ask the loan officer as you check out different lenders if your funds are limited.
How Long is the Repayment Period
The repayment period typically runs from 5 to 15 years. The shorter the repayment period, the less interest you pay. Before choosing a 5-year home loan, however, be certain you can afford the higher payment. Choose a longer repayment period if it would be a strain.