With the appreciation we have seen in our market over the past few years and all the recent talk about a looming increase in interest rates, I have been receiving a lot of questions about home equity loans.
Simply put, many people are interested in using the equity they have accumulated in their homes to pay for a variety of important wants and needs, such as college tuition, debt consolidation, home renovations, boats or medical bills.
When home prices rise, that magical nymph called equity can seem to appear out of nowhere. It can be tempting to look at a home equity loan as free money, since the interest rates are low in comparison to credit cards. Monthly payments can seem relatively low, as well, because home equity loans can be financed over a term of up to 30 years.
The reality, however, is that home equity loans are not without risk and there are many things to know before you think about moving forward. One of the most important things to remember is that home equity loans are effectively a second mortgage.
Before you take out a home equity loan, you should understand that you could lose your home if something happens and you are unable to continue making the payments.
There are two main forms of home equity loans, each with a set of advantages and disadvantages. Historically, the most common type has involved the payment of a lump sum to the home owner. Two of the chief benefits to standard home equity loans are that the interest rate is fixed and equal monthly payments are made over the life of the loan. These are perfect if all you need to do is replace a roof, repair a driveway or fix an old deck, for example.
Another common type of home equity loan is the Home Equity Line of Credit (HELOC). This is for the homeowner that needs access to funds when necessary to cover emergencies or pay for major expenses, such as starting a small business or performing a significant, time-consuming home renovation.
A HELOC allows a homeowner to pull money out when it is needed, up to a predetermined limit and during a certain time frame. The period of time you can borrow funds is known as the draw, and it usually lasts about 10 years. What gets people into trouble is that HELOCs have variable interest rates and many of them don’t require you to make payments on anything except the interest while the draw period is still active.
After the draw period expires, it becomes necessary to begin making a full payment of both the interest and principal. The implication of this is that a homeowner’s payment on a HELOC can suddenly rise substantially. Some HELOCs, on the other hand, require a balloon payment for the entire balance of the loan at the end of the draw.
It’s easy to understand how people find it difficult to resist the temptation of only making interest payments during the draw period. What is truly shocking - and scary to think about - is many people don’t even realize the loan they negotiated and closed on 10 years ago has a balloon payment… until a notice arrives in the mail one day.
An important point to remember about both types of home equity loans is the minimum amount most lenders require is $10,000. Also, these types of loans are only available if you have a strong equity position in your home. In most cases, a lender will require you to have at least an 80 percent equity position, after the loan amount has been added to the debt.
While home equity loans and HELOCs are not without risk, they can be extremely useful and effective financing tools if approached with a little bit of caution and understanding.
For a confidential evaluation about your situation and the options available to you, please contact me at the number below.
Patrick Stoy (NMLS Numbers 39527 and 39166) has 16 years of mortgage lending experience. Patrick is CEO of Wilmington-based Market Consulting Mortgage, which he started in 2005 with a mission to build lifelong customer relationships by providing real value. To learn more about Marketing Consulting Mortgage, visit www.macmtg.com. Patrick can be reached at [email protected] or 910-509-7105.