Home equity: Everything you've ever wanted to know
As a homeowner, you want to strategically put your financial asset to good use. Many members wield the power of their home through a home equity loan or line of credit to cover large expenses. But you may have concerns or questions, wanting to protect this substantial asset. We’ll walk you through an in-depth look at how home equity loans and lines of credit work, their advantages and disadvantages, some things to consider and address common questions. If you’re looking for a quick overview, skip to the FAQ section at the end.
First, what’s equity?
When you purchase a home, you obtain a mortgage, or loan, with the intent of repaying the full amount. Equity is the amount of the home you have paid off—essentially, what’s yours. The longer you’ve owned your home, the more equity you have, as more of your mortgage is paid off. If your home is valued at $300,000 and you have paid $150,000 towards your mortgage and in your down payment, your total equity in the home is $150,000. Equity is the difference in your home’s fair market value and the outstanding balance in your home. Homeowners can use equity to secure a home equity loan or line of credit.
Can I borrow against all the equity in my home?
Typically no, homeowners cannot borrow all the equity in their home. At Earthmover Credit Union (ECU) you can borrow up to 85% of your home’s value.
To calculate home equity, first multiply the appraised value of your home by 85%. Next, subtract your mortgage balance (and second mortgage balance, if applicable). The remainder is the amount available to borrow.
To demonstrate, let’s go through an example. If your home is valued at $300,000 and you owe $150,000, ECU can lend you up to $105,000.
$300,000 x 0.85 = $255,000
$255,000 - $150,000 = $105,000
When homeowners calculate their equity, double-checking the math is crucial, as it’s easy to overestimate the amount available for a home equity loan. Remember, you can’t borrow against all the equity in your home. While you may have paid off $150,000 of your mortgage, this does not mean you can borrow $150,000.
Home equity loan vs. home equity line of credit
A home equity loan is a loan that uses your house as collateral. A fixed-rate home equity loan has a fixed interest rate, term and payment. The payment will not fluctuate. After the loan is paid, it is closed.
A home equity line of credit is similar to a credit card. As an open line of credit, it can be borrowed against at any time. The rate is variable and based on the prime lending rate, so the payments may go up or down. Because the loan or line of credit is secured with your house as collateral, the interest rate is generally lower than that of other loan products, like an unsecured personal loan. This can make financial sense if you need a large amount. A home equity line of credit offers flexibility; the money is available, if and when you need it.
Different options provide different solutions.
What can I use the money for?
Home equity loans have a variety of purposes, but they are frequently used for home renovations, college tuition or purchasing a second home. They can also be used to consolidate debt. Equity in your home can be used to fund current financial needs or assist with future plans, such as purchasing a second home or investment. The lower interest rate and longer terms keep payments manageable.
I don’t want to mess with my mortgage.
A home equity loan or line of credit does not affect your mortgage. If you’re concerned whether or not a home equity loan would jeopardize your existing mortgage—either by affecting your interest rate or payment—don’t be. Your mortgage remains untouched, regardless of what you do with the equity in your home.
Keep in mind.
There are significant things to consider when determining if a home equity loan or line of credit is right for your situation. First, decide whether or not you will be moving soon—your home equity loan needs to be repaid in full when you sell your home. If you are interested in selling your home in the near future, this may not be the best financial option.
Second, understand the difference between a home equity loan and a home equity line of credit when evaluating your needs. Do you need one large sum all at once or do you need funds you can draw from over time? A home equity loan is a closed end loan with a fixed payment and term. This means that the payment remains the same each month, as the interest rate is fixed. However, with a home equity line of credit, the interest rate is variable, which means the rate and payment can change. Consider the advantages and disadvantages of both.
Ultimately, obtaining a home equity loan or line of credit is similar to taking out any other loan. It may be a short-term solution to your money needs, but make sure it fits into your long-term financial plan.
FAQ: I STILL HAVE A QUESTION
Let’s dive into some other common questions individuals often have about home equity loans.
When calculating equity, do I use my home’s current value or value when I purchased it?
For the purposes of a home equity loan, the home value means the current home value. An appraisal will determine the current value of the home.
Do I need an appraisal?
Yes, homes need an appraisal in order to move forward with a home equity loan or line of credit. This may involve a full appraisal or an exterior-only appraisal. In rare cases, we may waive the appraisal for very small amounts. If you are applying for a home equity loan product, expect an appraisal.
How much equity can I borrow?
You can borrow up to 85% of the home’s value, minus what is owed, as you need to retain 15% equity in your home. Other programs may be available from time to time.
Do I need to have owned my home for a certain period of time?
While there is no time requirement, the shorter the length of homeownership, the less time you’ve had to accrue equity. If you have not owned your home for long, we will determine eligibility for a home equity loan product on a case-by-case basis. Having been a homeowner for more years puts you in a stronger position to borrow more money.
Why should I pick a home equity loan over a personal loan or credit card?
This is an important consideration, and we can provide the best guidance if we know your financial situation, plan and goals. A home equity loan or line of credit is a secured loan, and can provide lower interest rates than other products, putting the equity you’ve accrued in your home to good use. Given the fixed-rate and fixed-term nature of a home equity loan, it can be a good fit for those looking to consolidate debt, pay for tuition or fund a major expense that could end up being costlier through other avenues.
Will a home equity loan or line of credit affect my mortgage?
No, a home equity loan or line of credit does not affect your mortgage.
What happens when I want to sell my home?
If you still owe a balance on your home equity loan or line of credit, the loan must be paid off with the proceeds of the sale of your home and if your loan was a credit line, it must be permanently closed.
I want to apply. What should I expect?
Closing a home equity loan typically takes 30 days. First, we’ll discuss your goals and plans for the loan, after determining the amount of equity available. We always want to determine which program, product or solution will best fit your situation and needs. Then, we’ll take the application and provide a list of documents needed. This will likely include a month of paystubs, two years of recent W2’s, a copy of the mortgage statement and homeowner’s insurance policy. If you are retired, we would need a copy of your retirement income statements (i.e. Social Security award letter, pension statement). If you are self-employed, we need two years of your most recent personal and business tax returns, in addition to a year-to-date profit and loss statement. Our goal is to keep the process as easy and straightforward as can be. Our team is always available to answer your questions or provide support and resources.
To sum it up.
A home equity loan or line of credit can be a fantastic fit for many, effectively utilizing the equity you’ve earned in your home to assist with large financial needs.
Is your question still unanswered? We’re happy to provide you the answer. Contact us today and we’ll connect you with the right person to help.