Definition of home loan

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What is a Home Equity Loan?

A home equity loan – also known as an equity loan, home equity installment loan, or second mortgage – is a type of consumer debt. Home equity loans allow homeowners to borrow against the equity in their home. The loan amount is based on the difference between the current market value of the home and the homeowner’s mortgage balance due. Home equity loans are usually fixed rate, while the typical alternative home equity lines of credit (HELOCs) generally have floating rates.

The central theses

  • A home equity loan, also known as a “home equity installment loan” or a “second mortgage,” is a type of consumer debt.
  • Home equity loans allow homeowners to borrow against the equity in their home.
  • The home loan amount is based on the difference between the current market value of a home and the mortgage balance due.
  • Home equity loans come in two flavors: fixed rate loans and home equity lines of credit (HELOCs).
  • Fixed rate home equity loans offer a lump sum, while HELOCs offer borrowers revolving lines of credit.

This is how a home loan works

In essence, a home equity loan is related to a mortgage, hence the name second mortgage. The home serves as collateral for the lender. The amount a homeowner is allowed to borrow is based in part on a combined mortgage lending value (CLTV) of 80% to 90% of the home’s appraised value. The amount of the loan and the interest rate naturally also depend on the creditworthiness and payment history of the borrower.

Traditional home equity loans, like conventional mortgages, have a fixed repayment period. The borrower makes regular, fixed payments that cover both principal and interest. As with any mortgage, if the loan is not repaid, the home can be sold to pay off the remaining debt.

A home loan can be a great way to convert the equity you have built in your home into cash, especially if you are investing that money in home renovations that will add value to your home. Always remember, however, that you are putting your home at risk – if property values ​​go down, you could end up owing more than your home is worth.

If you are about to move, you may lose money selling the home or you may not be able to move. And when you get the loan to pay off credit card debt, resist the temptation to re-upload those credit card bills. Before doing anything that will put your home at risk, consider all of your options.

Special considerations

Home loans exploded after the Tax Reform Act of 1986 because they gave consumers a way to bypass one of the most important provisions – the abolition of interest deductions on most consumer purchases. The law left one major exception in place: interest on residential debt.

However, the Tax Cuts and Jobs Act of 2017 suspended interest deduction on home loans and HELOCs until 2026, unless, according to the IRS, “they are used to buy, build, or significantly improve the taxpayer’s home that the most.” Loans. “The interest on a home equity loan that is used, for example, to consolidate debt or pay a child’s college tuition, is not tax deductible.

Before you take out a home loan, be sure to compare the terms and interest rates. When searching, “don’t just focus on big banks, consider getting a loan from your local credit union instead,” recommends Clair Jones, a real estate and moving professional who writes for Movearoo.com and iMove.com. “Credit unions sometimes offer better interest rates and more personalized account service when you’re willing to deal with slower application turnaround times.”

As with a mortgage, you can ask for an estimate in good faith, but before doing so, you should make your own honest estimate of your finances. Casey Fleming, mortgage advisor at C2 Financial Corporation and author of The Credit Guide: How To Get The Best Mortgage Possible, Says, “You should have a good understanding of your creditworthiness and home value before applying to save money. Especially when evaluating [of your home]which is a significant cost. If your appraisal is too low to support the loan, the money is already out ”- and there are no reimbursements for failure to qualify.

Before signing – especially if you are using the debt consolidation home loan – do the numbers with your bank and make sure that the monthly payments on the loan are actually less than the sum of all your current commitments. Even if home equity loans have lower interest rates, your new loan term may be longer than that of your existing debt.

The interest on a home equity loan is only tax deductible if the loan is used to purchase, build, or substantially improve the home on which the loan is secured.

Home Loans vs. HELOCs

Home equity loans offer the borrower a one-time, lump sum payment that is paid back over a set period of time (usually five to 15 years) at an agreed rate of interest. The payment and the interest rate remain the same over the term of the loan. The loan must be repaid in full when the underlying home is sold.

A HELOC is a revolving line of credit, similar to a credit card, that you can draw on, pay back, and then draw back for a period set by the lender. The drawing period (five to 10 years) is followed by a repayment period during which no further drawings are permitted (10 to 20 years). HELOCs usually have a floating rate, but some lenders offer fixed rate HELOC options.

Advantages and disadvantages of a home loan

Home loan offers a number of main advantages, including costs, but also disadvantages.

advantages

Home loans provide an easy source of money and can be valuable tools for responsible borrowers. If you have a stable, reliable income and know that you can pay back the loan, low interest rates and potential tax deductions make home loan options a wise choice.

Obtaining a home loan is quite easy for many consumers as it is a secured debt. The lender will do a credit check and order a valuation of your home to determine your credit rating and combined mortgage lending value.

The interest rate on a home loan – albeit higher than that of a first mortgage – is much lower than that of credit cards and other consumer loans. This helps explain why the main reason consumers borrow a fixed rate home loan against the value of their homes is to pay off credit card balances.

Home loans are generally a good choice if you know exactly how much to borrow and what you will be using the money on. You are guaranteed a certain amount, which you will receive in full upon completion. “Home equity loans are generally preferred for larger, more expensive goals like remodeling, paying for college education, or even debt consolidation because the funds are received in one lump sum,” said Richard Airey, a loan officer at First Financial Mortgage in Portland , Maine.

disadvantage

The main problem with home equity loans is that they can be an all too easy solution for a borrower who may be caught in a perpetual cycle of spending, borrowing, spending, and deeper debt. Unfortunately, this scenario is so common that lenders have a term for it: “reloading,” which is basically the habit of taking out a loan to pay off existing debt and freeing up additional credit that the borrower can then use to borrow additional purchases.

Charging creates a spiraling debt cycle that often persuades borrowers to turn to home equity loans that offer an amount equal to 125% of the equity in the borrower’s home. This type of loan is often associated with higher fees because since the borrower has borrowed more money than the house is worth, the loan is not fully collateralised. Also note that interest on the portion of the loan that is above the value of the house is never tax deductible.

When applying for a home loan, the temptation to borrow more than you need right now can be great as you will only receive the payout once and you will not know if you will be eligible for another loan in the future.

If you’re thinking about a loan that is worth more than your home, it may be time for a reality check. Couldn’t you live within your means when you only owed 100% of the equity in your home? In this case, if you add 25% plus interest and fees to your debt, expecting you to get better is probably unrealistic. This could be a slippery descent towards bankruptcy and foreclosure.

Example of a home loan

For example, let’s say you have a $ 10,000 auto loan at 9% interest with two years remaining. Consolidating this debt into a home loan at a rate of 4% with a five-year term would actually cost you more money if it took you to repay the home loan every five years. Also, remember that your home is now used as collateral for the loan in place of your car. Failure could result in his loss, and losing your home would be far more catastrophic than handing over a car.

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