Home Equity Loans: What They Are and What They Can Do for You

Home Loan

If you’re a homeowner, you know that with every mortgage payment you make, you’re building equity in your home. Equity is the amount of your home you own at a given point in time. Every time you pay toward your mortgage loan’s principal, you are building that amount of equity. The longer you’ve been paying on your mortgage, or the more your home has gone up in value (or both), the more equity you will have.

One of the benefits of building equity is that it is an asset. You can borrow against your equity with a home equity loan or line of credit.

What is a Home Equity Loan?

home equity loan is a loan from a lender, such as a bank, credit union, or mortgage broker, for an amount less than or equal to the available equity in your home. Sometimes called a home equity installment loan, these loans typically have fixed rates, predictable and stable monthly payments, and a fixed term, usually between five and 30 years of repayment.

Home equity loans are disbursed in a lump sum, and people tend to use them for large expenses such as home repair or remodeling, college tuition, medical expenses, a wedding, a large purchase, or even to buy a second home or vacation home.

Another term for a home equity loan you may have heard is a second mortgage. You already have your first (primary) mortgage on your home that you got at the time of purchase. A home equity loan is secured by the equity in your home. That lender now owns part of your home until you pay off the loan.

When you take out a home equity loan, you now have two mortgages: the first one from the time of purchase, and the second one for the equity you borrowed. Just like with your primary mortgage, if you default on a home equity loan, the lender can foreclose and take possession of your house.

How Does a Home Equity Loan Work?

Home Loan

The terminology for a mortgage or home equity loan can be confusing, leading many people to ask “How does a home equity loan work?” and “What can a home equity loan do for me?” At TwinCity Lending, we specialize in first and second mortgages, and we can guide you through the process of choosing, qualifying for, and closing on a fixed-rate home equity loan.

Home equity loans work much like your primary mortgage. Your lender must determine your ability to borrow or your creditworthiness. To do so, they will evaluate your income, expenses, debts, and payment history. They will also consider your FICO, otherwise known as your credit score.

Determining your home’s current value is an integral part of the home equity loan process. Your lender will require a new property appraisal to obtain the amount your home is worth. The appraiser will look at the condition of your home, any upgrades you have made, and the sales price of comparable properties in the area that have recently sold.

With the appraisal in hand, your lender will then determine how much equity you have available in your home. Subtracting the balance on your mortgage (how much you still owe on your home) from the appraised value provides the calculation for the amount of equity you have. Depending on your creditworthiness and your lender’s standards, you may not be able to borrow the entire amount of equity you have.

Your lender will then ask how much of this equity you would like to borrow. This amount adds to the balance of your current mortgage and then gets divided by the home’s appraised value to obtain the combined loan-to-value (CLTV) ratio. How high or how low this percentage is will determine whether you are eligible for the loan or what your interest rate will be. A lower CLTV will qualify for a lower interest rate, and vice versa.

Since a home equity loan is a mortgage, you will have to go through closing a second time. That means a new title search to ensure there are no other liens or encumbrances on your property. There also may be origination fees or other closing costs. Often, these get rolled into your new loan, so you typically do not have to bring any cash to closing.

Fixed-rate home equity loans have a specific rate that is fixed (stays the same) over the entire term of the loan. That means that the interest rate will not increase (or decrease) according to the market. A fixed-rate home equity loan is predictable, as you have the same payment amount due every month for the entire loan, which assists with your budgeting. It is also stable since it does not swing with the market. The rate that you qualify for will be based on your credit-worthiness, the length or term of the loan, and the combined loan-to-value of your mortgages and your home.

What Can Home Equity Loans Do For You?

Home equity loans often have lower interest rates than other types of debt, especially credit cards. A fixed-rate home equity loan can be an excellent choice for debt consolidation and paying off higher-interest loans. They are also commonly used to pay for college tuition or a wedding for your children, or another large expense. Some people borrow against their home’s equity to get the down-payment to purchase a vacation home, retirement home, or even a rental property.

Unlike other types of debt, mortgage interest is generally deductible on your federal income taxes, so there may be some tax advantages for you to use a fixed-rate home equity loan for your borrowing needs.

Let TwinCity Lending Help

We have helped hundreds of Minneapolis and St. Paul area homeowners navigate the home equity loan process. We are standing by to help you, too. Our friendly and knowledgeable staff will help you determine how much equity you have to borrow, and what type of loan will be right for you. Contact us today to see if a fixed-rate home equity loan will help you with your financial plans and life goals.

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