When applying for a home loan or credit line, the existing equity serves as security. Home equity can be calculated by subtracting the balance owed against the home loan from the estimated home value. Unfortunately, the banking and real estate crisis has used up the equity capital of many homeowners due to significantly lower real estate values.
Before committing to tying up home equity in second mortgages or lines of credit, borrowers must decide if this is the best financial option. Most borrowers have every intention of paying off home loans, but even the best plans can fail. By using real estate as collateral, homeowners could put their property at risk of foreclosure.
Homeowners need home equity loans for many reasons. Some of the most common include home renovations and credit card and unsecured loan repayments. Home loans can be a good choice for borrowers who have more than $10,000 in outstanding debt.
The interest rate on home loans can be significantly lower than the interest rate on unsecured loans. By transferring debt to a soft loan, borrowers can save hundreds of dollars in interest costs.
Some people take out home equity loans to consolidate college loans. There are several ways to consolidate student loans without using real estate as collateral. Postgraduate students on federal student loans should learn about alternatives to educational loan consolidation by visiting the Department of Education’s website at ed.gov.
Graduates who have multiple private college loans can access credit consolidation resources through SallieMae.com. In addition, banks and credit unions offer options to consolidate private and state college loans.
Homeowners who need to make renovations or consolidate unsecured debt may find a home equity line of credit a better option. HELOC loans provide borrowers with a line of credit that can be drawn on as needed. Mortgage lenders base the amount of available credit on the amount of accumulated equity along with the borrower’s credit history and FICO score.
Borrowers only have to pay interest on funds they borrow from their line of credit. For example, a homeowner receives a HELOC loan with a $30,000 line of credit and borrows $10,000 for home renovations. The bank charges interest on the $10,000, not the full amount of available credit. Each time homeowners make a payment, their available line of credit increases.
Borrowers can choose to repay the borrowed money in a lump sum payment or in a monthly installment plan. A unique feature of HELOC loans is that for the first ten years, borrowers can choose to pay only the interest that is projected on funds borrowed. After that they enter the drawing period and have to pay the outstanding amount in full.
Depending on the circumstances, getting a second mortgage may be a better choice than taking out a home equity loan or line of credit. With a second mortgage, homeowners borrow a fixed amount of money that is paid in monthly installments over a period of time.
Homeowners should take the time to thoroughly research each type of home loan to determine which one is best suited to their needs. For most people, their home is their most valuable asset. Securing a loan with real estate can have serious consequences if borrowers are unable to meet loan payment obligations.
The best source for accurate home equity loan information is the Federal Reserve Board’s website at FederalReserve.gov. Visitors can learn how home equity loans are repaid; understand what to look for when buying a home loan; and use loan calculators to calculate the cost of obtaining a home equity loan or line of credit.