Looking for a way to finance large or unexpected expenses? Home loans based on your property’s equity have recently become increasingly popular. Why? Frankly, the interest rates are often much lower than the rates available for credit cards and can provide access to funds by allowing the applicant to borrow against the equity in their own home.
Another advantage comes in the form of interest. The loan interest one pays may even be tax-deductible. Consult with your tax advisor and make sure this applies to your current situation.
Types Of Home Loans Based On Your Property’s Equity
You can use the equity in your property in two ways. Either as a home equity loan or as a home equity line of credit.
HELOCS
A home equity line of credit can be used for multiple purposes thanks to its increased flexibility, with the added advantage that it can improve one’s credit score over time.
The top 5 reasons borrowers apply for a HELOC are:
- Paying off debts
- Paying off CRA or property taxes
- Home renovations
- Covering urgent expenses such as getting by after a job loss
- Business capital
What Type Of Loan Is a Home Equity Line Of Credit?
A home equity line of credit — HELOC, for short — works similar to a revolving line of credit. The difference is that rather than receiving a lump sum, the applicant can borrow as much or as little money as they need at any given time. A maximum credit limit applies, of course.
When the applicant is approved for a line of credit, they will receive either checks or a credit card to use when they desire to draw against the said line of credit.
Dividing a HELOC
A HELOC can basically be divided into two periods:
- First, by DRAW PERIOD. This is when the line of credit can actively be used.
- Second, by REPAYMENT PERIOD. This defines the amount of time during which the borrowed amount must be paid back.
In most cases, your minimum monthly payments during the draw period will only be represented by the interest. The principal payback will only take place during the repayment period. This may lead to a higher monthly payment or even balloon the payment later on. If the borrower chooses to cover the principal during the draw period, they’ll be able to borrow again until the draw period expires.
Main Benefits Of a HELOC
Flexibility is considered to be the main benefit of applying for a HELOC. Same as resorting to your home loan‘s equity, you are free to use the home equity line of credit in any way you want. However, it’s mainly recommended for long-term, ongoing expenses such as home renovations, medical bills or college tuition. The percentage of your home’s appraised value — counting out what is still owed on the first mortgage — determines the amount you can be approved for.
HELOCs usually have variable interest rates. They are based on index fluctuations. For example, the prime rate fluctuation.
Getting a Loan Based On Your Home’s Equity
Home equity loans are also called Second Mortgages. They provide access to a lump amount of money that you can agree to pay back at any time. Most Home Equity Loans are not amortized but if you prefer some will amortize up to a 35 year amortization.
The application process requires a market value appraisal for your home — same as with the HELOC. Home equity loans are considered best suited for large, one-time expenses. Can include short-term home improvements or maybe acquiring a new car. This type of loan usually comes with a fixed interest rate.
Main Benefits Of Using Your Home Loan’s Equity
Home equity loans have several potential benefits. The main benefit of taking advantage of your home’s equity is that it gives you access to a lump sum of cash that you can use for a variety of purposes, such as to pay down debt, make home improvements, or take a vacation.
Another advantage of home equity loans is that they are typically available with flexible repayment terms.
Home equity loans are also available to people with low credit scores and other disadvantages.
Additionally, home equity loans can be an excellent way to boost your credit score if you ensure that you’re paying your monthly mortgage on time.
Home equity loans are not right for everyone, however. If you have high-interest debt and little or no equity in your home, there may be more cost-effective ways to get out of debt.
Also, if you plan to sell your home soon, it may make more sense to invest in another property rather than financing your current one.
Ways To Use an Equity-based Home Loan
Manage Debt
A HELOC may prove to be a smart way to manage your debt — without solving it per se. A payment plan is a good place to start.
You may choose to convert a portion of your HELOC into a fixed repayment amount debt, similar to a mortgage loan. This may help you make regular payments in the long run. The interest rate and debt terms may vary from those on your HELOC, so it’s always a good idea to ask your lender for extra info. Budget planning can help you better adjust your spending towards a swifter debt payoff.
A Solution For Unexpected Expenses
Home loans based on your property’s equity are a great way to manage unexpected expenses and emergencies — losing a job falls into this category. Borrowing money to cover monthly bills over a longer period may have negative consequences, such as not being able to pay back your debt. Consider all risks before using a home equity line of credit to cover unexpected expenses.
A Solution For Investments
Many applicants settle for a home equity loan to use towards investing. Balance all the “if’s” before making your move and be confident that the amount of risk is tolerable. Risk factors include rising interest rates on your loan and a decline in your investments. These instances may put pressure on your repayment ability.
HELOC Transfer
The borrower has the option to transfer their mortgage and HELOC when the mortgage comes up for renewal. Of course, legal and other administrative fees will be part of the switch. In some cases, you may be required to pay off all other forms of credit — credit cards, for example — that are included within a joint mortgage-HELOC contract. A lender may help you negotiate some of the transfer costs.
Understanding The Terms
When committing to a line of credit or a home equity loan, the applicant is basically wagering their home as collateral. Before signing the dotted line, make sure you understand the contract terms — whether it is a loan or line of credit — and only borrow an amount that your budget can handle.
A fixed-rate home equity loan will require a strict payment schedule. This means you will be constantly aware of the monthly payment amount you will need to cover. A HELOC deal will allow you to be more flexible and use the draw period to make interest-only payments.
Keep in mind that to cancel your home equity line of credit, you need to pay it off first. Usually, there is a 10-day cancellation period if written notice is provided.
Final Thoughts
Home equity loans and home equity lines of credit usually offer a range of benefits, including lower rates, tax deductions and more.
If you are in the market for a loan and want to borrow against your home equity, the best thing you can do is to speak with a mortgage broker.
They’ll be able to tell you whether or not you are eligible for a loan and recommend a HELOC over a fixed-rate or a variable-rate home equity loan option. They also have access to traditional and private lenders and can help you choose the best lender for your needs. Home loans based on your property’s equity are not for everyone, but they can be a great way to borrow against the equity value in your home.
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