What is a Home Equity Loan and why you should consider one?

Home equity Loan, also called Home Equitiy Line of Credit or HELOC, is money that is being borrowed against the equity of your home. Most mortgage lenders will require the borrower to pay only the interest of the loan and will have the option to repay the balance in increments sums.  An important reason as to why a homeowner will choose a home equity loan is because he wants to cashout from the equity of his real estate. Cashing out from your real estate will have some restrictions such as LTV known as Loan to Value, mortgage lenders will make sure that the loan will not exceed the value of your real estate and, in most cases, will be much lower then the value.

The reason why mortgage lenders will loan normally up to 80% of the value is because they want to feel secure in ase of the loan gets defaulted. The way mortgage lenders calculate the LTV (loan to value) is as follow: The mortgage divided by the value of your real estate equals the percentage of your LTV.  For example: You owe the bank $50,000 dlls.and the value of your home is $100,000 dlls. $50,000 divided by $100,000 = 50% LTV. The lower the loan to value, the higher is your cashout and lower your interest rate because the bank has less risk.  Please refer to the chart below for a better understanding.

 

  

50,000 / 100,000 = 50% LOAN TO VALUE (LTV)

 

Why will the bank take the risk to lend you the money?

 

First of all, we all know that the only reason banks are in business is because people need money.  So banks are in the business to lend money and not just to protect your money in a bank account.

Think about it:  if you have a bank account all you get in return for depositing your money there is 1.5%.  In most cases the bank will not even charge anything to keep your account active. Have you ever wonder why banks don’t charge you for this service?  Financial institutions will not charge because they are using your money to lend other people for a much higher interest rate.  For example: You deposited in your bank account $10,000 and the bank offered you 1.5% APR (Annual Percentage Rate) that is $150 that you have made in a year to have your money in their bank. Now the bank will take your $10,000 and will lend it to your neighbor across the street for an APR of 14% to 29%.  In dollars we are looking at the bank profiting from your money  anywhere from $1,400 to $2,900 a year. What do you think, are banks in the wrong business?

 

 

How do mortgage lenders qualify homeowners to a home equity loan, HELOC?

 

First of all, we already know that the banks will calculate the LTV (loan to value) and make sure the LTV is as low as it can get, the lower the LTV the better deal it is for the mortgage lender.

The second step the bank will take is to look at your credit. Since home equity loans have higher risk for the banks because they are in second position they would want to make sure that you intent to pay the loan back and not default on the loan eventually. Good credit for banks is not necessarily 750 and above Fico score, you can have a lower fico score such as 680 or 650 and sill qualify for a home equity loan.  Mortgage lenders are looking for stability in payments and spending.  If you have good history in spending and paying back creditors and mortgage lenders you will qualify. 

Alsothe interest rate that you get will depend on your credit score. The third step, in my opinion, is the most important one, which is that the main requisite to get approved for any loan is your income. Mortgage lenders want to know that you will pay back the loan and the interest.  So if your income is high enough to pay back the loan and pay some other debt you might have, plus some expenses, then you will qualify for a home equity loan.

 

How do mortgage lenders calculate if your income is good enough to qualify?

 

In order for mortgage lenders to qualify your income to support the loan they will calculate the Debt to income ratio also known as (DTI).  Mortgage lenders will look at all your expenses and divide it by your income then they will know if you can qualify for the home equity loan.  For example: Your expenses are $2,000 every month, including credit cards debt, home mortgage, auto loan, personal loan and some other expenses you have. Your total income is $6,000 a month.  What they do is: they take your expenses $2,000 and divided it by your income $6,000.

 

  

 

I believe that 33% is a good deal to the bank, they know that you have enough cushion to repay their home equity loan so you are fine. Most mortgage lenders will require at least 45% DTI.

Why you should consider a Home equity Loan, HELOC?

 

I think that I should ask you the same question. You are a homeowner and there was a reason why you chose to become own a home. Yes owning a home is what society sees as the “American Dream” but also to invest in yourself rather than paying someone else’s investments. Now that you’re a homeowner you really don’t need to have many credit cards just to have some spending money.  Ccredit cards interest rates are too high and they will lead you to a much bigger debt than you even know. Credit cards interest rates are as high as 33% and your home equity loan will not exceed 8% these days.  For example: you used your credit card and spend $5,000 with an interest rate of 33% and on your neighbor accross the street took a loan for the same amount of money, but he used his home by getting a home equity loan with an interest rate of 8%.

Here are the two scenarios: you will have to pay back $5,000 + $1,650 (33%) = $6,650 in total and your neighbor will pay back $5,000 + $400 (8%) = $5,400. Your neighbor saved $1,250 because he used his home to get the money at a lower interest rate. If you want to save money and enjoy your home equity do it, but always remember to get a good interest rate and not settle for less then what you desrve.

 

 

 

Loan Amount $5,000

Interest Rate 33% (1,650)

Total Payback Amount $6.650

 

 

 

Loan Amount $5,000

Interest Rate 8% (400)

Total Payback Amount $5,400