Home equity is a financial asset you can use to raise money. Equity is the difference between your first-mortgage balance and the market value of your house. If you had a $150,000 mortgage balance on a house with a $300,000 market value, you would have $150,000 in equity. You can’t sell equity, but banks will accept equity as collateral to secure a loan. Collateral means you risk losing your home through foreclosure if you can’t repay your loan.
One way to tap into your home equity is refinancing your home with a new first mortgage for an amount greater than the balance on your old first mortgage. With this loan, you pay off your old first mortgage and receive your equity in cash. Interest starts accruing on the entire loan balance the day you close on the mortgage. You normally repay in fixed monthly installments over 15, 30 or more years. As a new first mortgage, a “refi” may carry a lower interest rate than other methods of cashing in on your home equity. A first-mortgage refinancing can look particularly attractive when prevailing mortgage interest rates are significantly less than the rate on your old first mortgage.
A second way to access your home equity is by a traditional second mortgage in which the equity lender provides you the entire loan amount in a lump sum at closing. Interest starts accruing on the entire loan balance the day you receive the funds. You generally repay a second mortgage by fixed monthly installments over a specified time period. Interest on any type of equity loan is higher than on first mortgage loans because the equity lender stands second in line. If the borrower defaults, the equity lender must wait until the first mortgage lender’s claim is satisfied. Interest paid on refinanced first mortgages and home equity loans is an income tax deduction.
Equity Credit Line
A third way to raise funds from your equity is with a home equity line of credit. In this loan, the equity lender provides you with a line of credit. You receive a checkbook or debit card that you use to take out money from the line of credit when you need funds, up to a maximum ceiling amount set by the lender. The lender charges interest only on the money you have taken out. You make monthly payments according to the amount you have taken from the line of credit. The more you take out, the higher your monthly payment becomes.
You may have options with mortgage refinancing and home equity loans. You can choose a loan with a fixed interest rate that doesn’t change for the life of the loan or a variable interest rate that adjusts up or down periodically, in line with prevailing market interest rates. You might be allowed to choose having each payment cover interest and a portion of the principal or to pay only interest at first and pay down your principal later.
Obtaining a Loan
If you want to refinance your first mortgage or obtain a home equity loan, shop around among multiple lenders. There are substantial differences among lenders regarding interest rates, loan terms, loan fees, closing costs and creditworthiness standards. All home lenders by law must disclose their interest rates, terms for any variable interest rate, closing costs, other miscellaneous fees and charges, and payment terms. Lenders can’t charge you any fees until you actually submit your loan application.
Once you select a lender and submit your loan application, the lender will check your income, total debts you owe, credit score, payment history and other indicators of your ability to repay. The lender also will order a real estate appraisal to establish the market value of your house. If you are approved for a first-mortgage refinancing, lenders may lend you up to 80 percent of the home's appraised value. Equity lenders generally limit loan size to the difference between the first-mortgage balance and 75 percent of the home’s value.
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