There are several ways to finance a big home improvement project. One is to refinance for cash out, the other is to apply for a home equity loan or credit. Here is what you need to know:
What is Equity?
Equity is the portion of the total value of your home that you actually own. If you have a 250,000 mortgage and you’ve paid 50,000 of it so far, you own one fifth or 20% of your home. This is known as the loan-to-value ratio.
How much Equity do I need in order to borrow against it?
Most lenders require you maintain a 20% equity stake in your home. Depending on how much you wish to borrow, you would need an equity position of 30% or more before you could even apply for a home equity loan.
What types of Home Equity Loan products are available?
There are two types of home equity loan products available. The Standard Home Equity Loan is a fixed dollar amount that you borrow outright. The second is a Home Equity Line of Credit or HELOC. The HELOC allows you to withdraw small amounts of cash as needed from a fixed amount paying interest only on the amount of money you’ve used.
When should I consider a Home Equity Loan or HELOC?
These loans are intended for big projects. A minimum loan amount would be $10,000.The maximum depends again on how much equity you currently have.
First off, you can expect to find a better interest rate than you would on a credit card or other unsecured personal loan. Remember that a Home Equity Loan and a HELCO are both considered second mortgages and, as such, are available at either a fixed or adjustable rate.
Will I be expected to pay closing costs?
These types of loans generally do not have closing costs, but may have an application fee.
How should I choose between these two products?
As both are home mortgages they share one similar advantage. The interest on either may be tax deductible. Check with your tax advisor to be sure. If your project doesn’t require a large cash outlay up front, the HELOC has the advantage as you are only charged interest on the amount you withdraw.
Are there disadvantages?
Again, because these types of loans are considered a second mortgage they can be foreclosed on should you default on your payments. In the event you do so, your primary mortgage would be paid from the proceeds of the sale of your home by the bank. Your Home Equity Loan or HELOC would be paid second.
For more information regarding a Home Equity Line of Credit click here.