If you’re a home owner and find yourself in need of a large amount of cash to fund a major expense such as a renovation, medical expenses, or your kids’ college tuition, one type of loan you should consider is a home equity loan
Closing costs for HELs usually reach around 2-5% of the loan amount. As with first mortgages, lenders are open to negotiating the closing costs, so always make sure to speak to a few of the best lenders before applying for a home equity loan.
A home equity loan, or HEL, is a type of secured loan in which the borrower puts their home up as collateral. It is also known as a “second mortgage”, because it works in reverse to a traditional mortgage. In a traditional mortgage, the borrower pays the lender and the borrower’s home equity increases. With a HEL, or second mortgage, the lender pays the borrower a lump sum, and the borrower’s home equity decreases.
Another type of home equity loan worth considering is the home equity line of credit, or HELOC. Whereas a HEL is a fixed-rate loan paid in one lump sum, a HELOC is an adjustable-rate loan and is paid to the borrower up to an approved credit limit and on a per-needs basis.
Home equity loans are available to anyone who owns a significant portion of the equity in their home, set by most lenders at a minimum of at least 80-90% of equity. It can be applied to any major expense, including a home renovation or repair, medical expense, paying off credit card debt or other debts, or funding a child’s college tuition.
The process of applying for a HEL is roughly similar to that of applying for a first mortgage. Your lender will mostly likely inform you of the following requirements and limitation:
- Your credit will be checked, although your score may have a lesser impact on your lender’s decision than it would for a regular mortgage or an unsecured loan.
- You will need to have your home appraised, and your loan-to-value ratio (the ratio of equity or ownership you have in your home) will be closely examined when the lender makes its decision.
- Depending on the lender’s examination and the loan amount you requested: some lenders may be willing to offer you a loan worth up to 125% of your home’s value, i.e. 1.25 times the value of your home.
HELs and other secured loans take a lot of the risk away from the lender and place it on the borrower. In return for assuming the risk, lenders are willing to offer borrowers better loans with a number of significant benefits. Here are just a few of the benefits HELs offer to borrowers:
- TLenders are willing to overlook a less-than-perfect credit rating.
- Rates are typically lower than for personal loans and other types of unsecured loans.
- The payment periods are generally longer, giving you plenty of time to pay off the debt.
- According to the IRS, if the home equity loan is used to buy, build or substantially improve the taxpayer’s home that secures the loan, interest paid to the lender is tax-deductible.