When making financial decisions, it is important to understand how they work. This can ensure you get the best options and safeguard you against scams and unethical practices. These rules hold true to home equity loans as well. In fact, a home equity loan is one of the biggest financial decisions you will ever make. For this reason, a great deal of consideration should be placed on understanding how these loans work.
Determining Equity
Your equity is the amount of ownership you hold in your home. To determine this amount, you would subtract the amount that you still owe on the home from the value of the home. While many lenders may offer you a loan that exceeds this amount, moving forward with it would cause you to be upside down in your loan. This means that you would owe more than the home is worth. You should, instead, leave some of your equity untouched. This would leave you equity to borrow against in the future if a financial emergency were to arise.
Types of Loans
There are two types of home equity loans; home equity lines of credit and second mortgages. They each work differently and often have different repayment terms. Understanding these terms can help you determine which loan is right for your financial needs.
A second mortgage would provide you with a lump sum of money. This lump sum would be placed on a repayment schedule, much like your first mortgage, only with slightly higher interest rates. You will also be responsible for fees that are similar to your first mortgage like closing costs and origination fees.
A home equity line of credit allows you to tap in to your home’s equity, a little at a time. You often have a term that you can borrow against your home’s equity, usually ten years. Once the term is up, you may be required to pay your balance in full. However, you may be able to find a lender that will allow you a repayment term for the amount you have borrowed. Just be aware that the longer you have the loan out, the more interest you will pay.
The Importance of Comparison Shopping
Comparison shopping is essential to getting the best loan terms. It will also safeguard you from unethical or dishonest practices that some lenders may try to use. You should always get loan information in a written agreement called a Good Faith estimate. This will protect you from rising interest rates. It will also give you material to compare when looking at the different terms that each lender has to offer.
Where to Find a Home Equity Loan
You can obtain a home equity loan at almost any financial institution. This includes brokers, credit unions, banks, and online mortgage brokers. Some lenders, like credit unions, will require you to qualify for services at their branch before you can be considered for a loan. However, all lenders should require you to qualify for the loan itself.
Avoiding Dishonest Lenders
While most lenders are honest and upfront, there are always a few bad eggs in the bunch. These lenders are often pushy and try to pressure you into a loan that you don’t feel comfortable with. They avoid answering questions about rates and terms. They fail to address your needs. They may even falsify documents. They almost always fail to give you a Good Faith estimate. Avoid these lenders and cut all ties.
What to Use the Money for
What you use the money on is, ultimately, your decision. However, it is important to keep in mind that you are borrowing against the ownership of your home. By using the money wisely, you can increase your family’s net worth and better your financial situation. However, misusing this money can create a higher debt for your family.
Some of the best uses for home equity loans include the purchase of another home, paying for college tuition, repairs around your home, energy efficient appliances, and retirement funds. Some of the worst ways to use the money include debt consolidation, vacations, vehicles, and luxury expenses. These uses deplete your family’s net worth and increase your overall debt.
Things to Look Out for
While not all of these practices are illegal or deceptive, per say, many of them are terms that you may not be looking for. This can cost you thousands over the course of your loan. Balloon interest, prepayment penalties, check writing fees, hefty late fees, and account maintenance fees are the most common deal breakers. These should be avoided, if at all possible.
If You Are Denied
If you are denied for a home equity loan, consider other options that can help you obtain the finances you need. Because credit is a big determining factor in your home equity loan application, you may consider spending some time working on your credit history. However, you can also be denied for having a high debt-to-income ratio. Try clearing up your credit or reducing your amount of debt. Your lender should disclose the reason for your denial.