Everything You Need for Your Home Equity Loan
What is a HEL?
A home equity loan (HEL) is often referred to as a second mortgage. A home equity loan is money you borrow that is secured by your ownership stake in your home. Home equity loans are similar, in some ways, to standard primary mortgage loans. Both have fixed principal amounts disbursed when the loan closes, pre-set payment schedules, and either adjustable or fixed interest rates.
Home equity loans also share similarities with Home Equity Lines of Credit (HELOCs). Both HELs and HELOCs are loans that sit in a junior lien position to your primary mortgage. You use both to finance expenditures and purchases of a personal nature, such as debt consolidation, medical expenses, education costs, home improvement projects, and large-ticket items.
However, you should also be aware how home equity loans differ from standard mortgages, including refinance mortgages. A HEL has higher costs than a primary mortgage. The lender takes on a higher risk, because of its junior lien position and the fact that HELs have a higher rate of default. The lender charges you more to offset its risk. You may find it hard to take out a HEL from anyone other than your primary mortgage lender. A 'stand alone' second mortgage, a second mortgage taken on its own and not in conjunction with a first mortgage, is offered by far fewer lenders than was the case a few years ago .
HELs are different than HELOCs, because HELs have a fixed loan amount and payment schedule, whereas HELOCs are revolving lines of credit, only paid on as you use the credit line. Additionally, HELs require principal and interest for the life of the loan, while HELOCs allow a period of interest only payments. HELs usually are available with fixed interest rates, where HELOCs usually come with variable interest rates.
When to take a HEL
HELs are ideal for one-time purchases or use when you know how much money is required, such as debt consolidation or a home-improvement project with a fixed budget. Borrowing form your home equity may be the only way you can finance these events, as unsecured loans are now very difficult to obtain and if available are only available at very high interest.
The primary disadvantage of home equity loans is that if cannot make your payments, you put your home at risk for foreclosure. If you borrow a lot of the equity from your home and the value of your home drops, you may not be able to sell your home and pay back all the money you owe on it. When you have two loans, the total debt is referred to as the CLTV (combined loan-to-value). 90% CLTV is the most liberal CLTV maximum available for a HEL. Some lenders cap CLTV at 80%, some at 85%. The state you live in can also restrict the CLTV maximum and different states have different CLTV caps. Condominiums have stricter borrowing caps than single-family residences.
Qualifying for a HEL is harder than it used to be. Lenders have stiffened their requirements, in terms of maximum amounts they will lend and the credit worthiness that you must demonstrate.
If you're looking for a home equity loan, use Bills.com's Savings Center to find the best deal. When interest rates are low, you should look at all your borrowing options, including refinancing your primary mortgage, or taking out a second mortgage. When you understand what kind of loan best fits your needs, you increase your chances of finding the right loan.