Are you a homeowner in need of cash and are considering taking out equity in your home? Borrowing against your home’s equity is a way to consolidate bills, pay medical or educational expenses, or make home repairs. Understanding the different types of home equity loans will help you avoid paying too much for the financing; here are several tips to help you decide if borrowing against your equity is right for you.
Cash Out Mortgage Refinancing
Refinancing your home with cash back means taking out a new mortgage to pay off your existing loan while borrowing more than the payoff balance of your loan. The difference between your payoff balance and the amount you borrow will be paid to you in cash at closing. Cash back refinancing is great for homeowners who have a significant amount of equity to borrow against or if you need to improve the terms of your existing mortgage. It is important to remain in your home long enough to recoup the expenses from refinancing your existing mortgage.
Second Mortgage Loans
Taking out a second mortgage will get you a higher interest rate than if you were refinancing with cash back. The reason for this is that your home will be secured by two loans often from different lenders. The second lender shoulders more risk than the first and will pass that risk on to you the borrower with a higher mortgage rate. Second mortgages cost less in upfront fees than refinancing; however, because the loan is secured by your home the rates are typically lower than signature loans or credit cards.
Home Equity Lines of Credit
Using a Home Equity Line of Credit allows you to borrow as you need money and have the advantage of paying interest only on the loan’s balance. A home equity line can be an extremely flexible and many offer debit cards for ease of access to your funds. There is additional risk involved with a Home Equity Line of Credit as the ease of access to your equity may result in borrowing more than you intended. If you have difficulty managing your money this might not be the best loan for you.
Tax Deductible Interest
The interest you pay on cash out refinancing or home equity loans is typically tax deductible. If you borrow more than your home is worth or if you have second mortgages for more than $100,000 the IRS could deny your deduction.
Is a Home Equity Loan Right For You?
Make sure the reason you are borrowing warrants dipping into your equity. While the equity in your home belongs to you, it doesn’t make sense to borrow for something like a vacation or to purchase an automobile. If you need cash for some financial goal or to make improvements to your home or even start a business, cashing out your equity could be a wise financial decision. Remember that your home should not be the piggybank you dip into whenever you need a cash fix.
When refinancing your mortgage or borrowing against the equity in your home, the lender may require a recent home appraisal before approving your loan. Full blown appraisals typically run in the neighborhood of $300; however, there are ways to save money on your appraisal. There are four varieties of appraisals you should be aware of.
1. A complete home appraisal with photographs of the interior and exterior will set you back $300.
2. An exterior only home appraisal with photographs typically costs $250.
3. Drive by home appraisals cost as little as $100.
4. Electronic home appraisals, called Automated Valuation Model (AVM) use public records available on the Internet and provide an approximate value of your home based on the sale of comparable homes in your area and cost less than $100.
How do you know which type of appraisal you need? Your lender will determine which type of appraisal you need before approving your mortgage or home equity loan. If you’re purchasing your home with no or little down payment, or refinancing with poor credit you can expect the lender to require a full appraisal. If you have good credit with the required down payment of 20 percent, ask your lender if your approval qualifies you for a reduced appraisal which could save you $200.
Cash out mortgages are no different than conventional loans except that you walk way from closing with a check in hand. The money you borrow comes from your home equity and is added to the outstanding balance of your loan.
Suppose for example you refinance your 8.5% mortgage on a $175,000 balance to a new 6.5% loan. Instead of refinancing the balance of $175,000 you obtain a new mortgage for $200,000 and walk away with $25,000 to spend as you see fit. Sounds like a good deal, right? It can be a good deal; however, there are several things you need to be aware of to avoid making costly mistakes.
One common mistake homeowners make is borrowing too much compared to the appraised value of your home. Mortgage lenders don’t like your mortgage to exceed 80% of your homes value. If you borrow more than this amount the lender could require you to purchase Private Mortgage Insurance (PMI). PMI is expensive and could add hundreds of dollars to your monthly payment. If you borrow more than 80% of your homes value the interest rate you receive will be higher than if you stayed below the 80% threshold.
Mortgage lenders charge more and require Private Mortgage Insurance because the foreclosure rate on cash out mortgages is higher than the default rate on conventional mortgage loans. You can learn more about your cash out mortgage refinancing options, including expensive mistakes like Private Mortgage Insurance that you need to avoid, with our free mortgage video tutorial.
Qualifying for a home equity loan with bad credit is not as difficult as you think. Many homeowners with poor credit think their credit will prevent them from qualifying for a loan. This is simply not true, especially when it comes to home equity loans. Home equity loans are secured by your home just like your primary mortgage, and are the perfect vehicle for rebuilding your credit.
Having poor credit means you will pay more for the financing on your home equity loan. It is especially important for homeowners with poor credit to shop around for the most competitive home equity loan from a variety of lenders. When you compare home equity loan offers compare all fees for the loans you consider, not just the interest rate or annual percentage rate. Depending on the type of home equity loan you choose you will be required to pay many of the same fees you paid when you took out your mortgage. These fees vary widely from one lender to the next, so it pays to shop around.
Home equity loans come in two varieties: second mortgage loans and home equity lines of credit. Both options have advantages and disadvantages depending on your financial situation and the reasons for borrowing equity. Because you have poor credit you can expect to pay a higher interest rate and lender fees than a borrower with good credit; however, this does not mean you will pay outlandish fees. This is why comparison shopping for the best loan is important. When you comparison shop from a variety of lenders you can easily spot the ones that are trying to take advantage of you with excessive fees and interest rates.
You can learn more about your home equity loan options by registering for our free Underground Mortgage Videos.
If you are considering tapping your home equity for any reason, there are several loan options available to you. These options include home equity lines of credit, second mortgage loans, and cash out refinancing. Each type of home equity loan has advantages and disadvantages; the home equity loan option you should choose depends on your financial situation.
The type of home equity loan you choose will determine the type of interest rate you will receive along with the finance charges you will pay. Your mortgage lender may require you to have an appraisal prior to applying for your second mortgage; this appraisal is used to determine how much equity you have in your home. Equity in your name is the difference between what you owe on your current mortgage and the appraised value of your home.
The amount of equity you have in your home determines how much you can borrow. The interest rate you will receive depends on your credit score, loan-to-value ratio, and the type of loan you choose. When shopping for a home equity loan it pays to compare multiple loan offers to find a loan with the lowest interest rate and fees.
Second mortgage loans typically come with fixed interest rates; this is an advantage over home equity lines of credit. Before taking out a second mortgage you should plan your budget to make sure you can afford the monthly payment in addition to your primary mortgage, car payment, credit cards, and household expense. Remember that your second mortgage is secured by your home just like your primary mortgage. If you default on either loan the lender can take your home.
Many homeowners use second mortgages to consolidate other high interest debt such as credit cards and student loans. Consolidating multiple debts into one payment can ease your cash flow and do wonders for your budget. Consolidating does not eliminate debt, it simply shuffles it around to make it easier to repay. If you don’t change your spending habits you may find yourself further in debt.
You can learn more about your home equity options including common mistakes to avoid by registering for a free mortgage guidebook: “Five Things You Need to Know About Your Mortgage.”