Understanding Home Equity Loans
Thinking about refinancing your mortgage in order to put your home equity to good use? Good call! In this article you’ll learn about the two main types of mortgage refinancing available to you if you’re looking to access your equity. By the end of this article we hope you’ll have a clearer picture of whether or not a home equity line of credit is right for you, or if you are better off with a home equity loan, depending on your unique situation. If you need any more information contact our local Victoria Mortgage Broker today.
Did you know you have a few different options when it comes to accessing your home equity? As a refresher, your home equity is the current market value of your property, minus the amount still owing on your mortgage. Your equity is likely your most valuable asset and is built up through a combination of paying down your mortgage and your home increasing in value – either as a consequence of time, or through a renovation or remodel, for instance.
Many people who have built up enough home equity choose to put their equity to work for them, by either using the funds to buy a secondary property for rental income, consolidating higher interest rate debts, or investing in things like their children’s college education, or a big renovation of their existing home.
Accessing Your Home Equity – the Basic Concept
As a homeowner, when you walk into your bank and want more money, if you qualify, your bank is going to add to your existing mortgage charge. The way they add onto your existing mortgage is by either giving you:
- A new home equity loan, which registers as two separate mortgage levels under one registered charge on title; or
- A homeowner line of credit (HELOC).
The funds from either of these options will be secured under your first mortgage charge. Depending on whether or not you need all the money right away will affect which option is best for you, or, in other words, the way you borrow your additional funds.
Let’s take a closer look at the two main options to access your home equity: home equity loans and HELOCs.
Home Equity Loan
A home equity loan, not be to be confused with a second mortgage, is a structured way to access home equity. In this scenario, you’re adding a new mortgage level under your first mortgage level.
The home equity loan or new mortgage level acts just like your existing mortgage – you’re just simply borrowing more money from the lender, or taking on more debt at an interest rate that’s closer to the rate of your current mortgage than that of other types of loans. You’re essentially borrowing against your house, which assures the bank that you’re motivated and can pay back the loan.
With a home equity loan, you receive one lump sum payment that can be up to 80% of your home’s value minus what you still owe on it. The large lump sum can be put towards large purchases, such as secondary properties, right away.
You are required to pay interest on the full amount – just like your regular mortgage – and you agree to repay the loan in fixed amounts on a payment schedule. The fixed payment schedule can be beneficial in helping you stay on track with paying off the loan.
Payments partially cover the principal of the loan, and partially the interest. Again, it works just like your existing mortgage.
Home equity loans are closed term, which means there are penalties involved for paying them off early. They usually come with fixed or variable interest rates that can either be slightly higher, slightly lower, or right on par with the interest rate of your existing mortgage. They are amortized at the start and come with an agreed upon term of 10, 15, 20, or 25 years, etc. These types of loans cannot be drawn upon further once they are issued – you receive the money once in full and can’t ask for more without going through the refinancing process over again.
Fees Associated with Home Equity Loans
Applying for a home equity loan will involve administrative fees, such as appraisal and legal fees, and title search and title insurance fees.
In most cases, if you qualify for your home equity loan through the same lender as you have your existing mortgage with, there is no penalty for breaking the terms of your mortgage because you aren’t cancelling or moving your mortgage elsewhere. However, if you’re switching lenders, there will usually be some penalties involved.
Ask your mortgage broker if they help cover any fees!
Home Equity Line Of Credit
A Home Equity Line Of Credit, often referred to as a HELOC, is a secured line of credit in which your lender or bank uses your home as collateral to ensure you’ll eventually be paying back the money you’re borrowing.
Considered a revolving loan, a HELOC is more flexible that a home equity loan. With a HELOC, your lender typically allows you to borrow up to 65 to 80% of your home’s purchase price or market value, minus what you still owe on it. You don’t take the money as a lump sum, rather, you use only what you need, when you need it, and only pay interest on the amount you use.
In other words, a HELOC acts like a regular line of credit that you pay back on your own schedule – you’re only required to make the minimum monthly interest payments. With a HELOC, you can pay back the money and then borrow it again as needed. Some lenders will increase your credit limit to give you more borrowing room as you make great strides in paying off the principal. You can also pay back a HELOC in full without penalty.
Fees Associated with HELOCs
The administrative fees for HELOCs are the same as for home equity loans: appraisal fees, legal fees, and potential title search and insurance fees.
There are also no refinancing penalties associated with HELOCs.
Pros and Cons of a Home Equity Line of Credit
- Only pay interest on the amount you spend.
- No prepayment penalties.
- Flexibility in how much and how often you spend.
- Flexibility in how much and how often you pay down the principal portion
- Easy to access available credit.
- Variable interest rates.
- Requires discipline to make more than the minimum monthly interest payment.
- If you can’t keep up with the payments, your credit score will be negatively impacted.
When a Home Equity Loan is Best
If you need a large amount of capital upfront, a home equity loan is probably your best bet. Purchasing an income property, consolidating debts, paying off unexpected medical bills, or paying off your college tuition are all examples of times when you might need a lot of money all at once for a single purpose.
When large sums such as these are issued, having a fixed payment schedule and fixed interest rate can make things more manageable. Your payments can be set up automatically, requiring you to not have to think about them all that much.
A home equity loan ISN’T suitable if you only need small amounts of money here and there. Drawing a large lump sum that you aren’t investing or using might be too tempting to spend on things that aren’t helping you get ahead financially. It’ll quickly burn a hole through your bank account. Likewise, you’ll be paying interest on money that you’ve borrowed but haven’t spent yet.
When a HELOC is Best
A home equity line of credit is the better bet if you will only need to periodically access extra cash over a lengthier period of time, say for home improvements, a new car, starting your own business, growing your family, or annual family vacations.
HELOCs offer much lower rates than credit cards, and sometimes lower rates than car loans, so they make smarter financial sense for these larger expenses that don’t quite require an entire second mortgage. As a precaution, a HELOC is only suitable for disciplined homeowners who can manage to repay the entire balance within the designated time frame.
No matter what path you take to accessing your home equity, always be sure to study and understand all of the repayment terms of your loan before signing on the dotted line. You have options and can certainly shop around before settling on the first offer you see posted at the bank while you’re waiting in line.
Combining a HELOC with a Home Equity Loan
When accessing your home equity, it’s possible to use a HELOC to access only a portion of your available home equity, and then use a home equity loan for the rest of your available home equity. For example, if you have $250,000 of available home equity, you can access $50K via a HELOC, to say, finance a home renovation, and then access the rest of your home equity ($200,000) as a home equity loan to put towards an income property.
A mortgage broker can be instrumental in setting up this type of refinancing for you. They will start by finding out an overarching amount of money that is available to you through your home equity. You then let your broker know how much you want as a mortgage (home equity loan) and how much you want as a line of credit.
Your mortgage broker can help with these transactions at no cost to you while providing peace of mind that you’re getting the best rates possible, and the best refinancing options for your financial situation and accounting needs.
One of our mortgage brokers here at Olympic Mortgages in Victoria can go over all your options with you, as well as do all the shopping around on your behalf. It all starts with a simple phone call where we get to know each other.