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How Home Equity Loans Work: Rates, Terms and Repayment

| Using your equity

Home equity loans are a great way to tap the piggy bank that’s hiding in the value of your home. From debt consolidation to home improvement and even big ticket purchases (like a dream vacation), home equity loans can be the perfect resource to get the cash you need.

There are three types of home equity loans available to homeowners. They include:

  • Traditional Home Equity Loan:  This type of home equity loan allows you to borrow a fixed amount of money in one lump sum. With a traditional home equity loan, you can expect to have a fixed interest rate, loan term and monthly payment amount.  The interest you pay on a home equity loan may also be tax deductible.  Consult a tax advisor to learn more.
  • Home Equity Line of Credit (HELOC): This type of home equity loan is considered revolving credit because it allows you to borrow money as you need it with your home as collateral.  Most HELOC plans allow you to draw funds over a set amount of time known as the “draw period”. At the end of this period you may be able to renew the credit line and keep withdrawing money, but not all lenders allow renewals. Some lenders require borrowers to pay back the entire amount at the end of the draw period and others may allow you to make payments over another time period known as the “repayment period”.
  • Cash-Out Refinance Loan: This type of home equity loan allows you to borrow a fixed amount against the equity in your home by refinancing your current mortgage into a new home loan for more than you currently owe, and you take the difference in cash. With a cash-out refinance loan, the additional borrowed amount is combined with the balance of your existing mortgage.

Each home equity loan option varies slightly, and each variation offers different rates, terms and repayment options.

Rates, Terms and Repayment Options

The beauty of a home equity loan is the flexibility that’s available to you as a borrower. Because home equity loans offer multiple terms and repayment options, you can select a home equity loan based on your individual needs.

To help you understand how rates, terms and repayment options work, let’s discuss each aspect as they relate to the different types of home equity loans that are available to you.

First, let’s discuss popular home equity loan terms and what they mean:

Rates are the amount of interest charged as a percentage of your loan amount paid to the lender for the use of the borrowed funds. Interest rates can be variable, meaning they change over time, or they can be fixed, meaning they stay the same for the duration of your loan term. Some lenders refer to interest rates as your annual percentage rate, or APR. Your interest rate is the amount you pay to borrow the funds you want.

Loan terms vary depending on the type of loan you obtain, and they merely describe the amount of time you have to repay the loan. A home equity loan term can range anywhere from 5-20 years.  HELOCs generally allow up to 10 years to withdraw funds, and up to 20 years to repay.  A cash-out refinance term can be up to 30 years.

Repayment options are the various structures a lender provides for you to repay the borrowed funds. Usually, you will repay your loan on a monthly basis, and your loan is paid in full when the term ends. In some cases, as with home equity lines of credit, you might pay the interest only during the term of the loan and pay the full amount of borrowed funds when the loan term ends.

Equity can be calculated by subtracting all debts secured by your home from your home’s appraised value. For instance, if your home is worth $275,000 and your current mortgage is $100,000, then you have $175,000 of equity.

Loan to Value Ratio is the amount of your mortgage divided by the appraised value of your home. For example, if your mortgage is $100,000, and your home is valued at $275,000 your loan to value ratio is 36%. This means 36% of your equity is mortgaged.

Each type of home equity loan offers different rates, terms and repayment options.

The Rate, Terms and Repayment of a Traditional Home Equity Loan

A traditional home equity loan carries a fixed interest rate for the life of the loan. This means your interest rate will stay the same from your first payment until your last payment. The interest rate for a traditional home equity loan (also known as the APR or annual percentage rate) is based on several factors, including your existing mortgage balance, the value of your home, the term of the loan, the loan amount, your credit history and your income.

When you make payments on a traditional home equity loan, you are paying both the principal and interest on the loan with every payment.

Discover Home Equity Loans offers 10, 12, 15 and 20 year home equity loans in amounts from $35,000 to $150,000. The term of your loan dictates whether you have a high or low monthly payment.  The longer the loan term, the lower the monthly payment.  With a traditional home equity loan, once the term of your loan has ended, you should have paid off all borrowed funds and interest.

With Discover Home Equity Loans, you can usually borrow up to 90% of your combined loan to value ratio (CLTV).  In some cases you can get up to 95%, depending on your credit score. You can calculate CLTV by taking your desired loan amount plus mortgage balance, then dividing that number by your home value. So, in most cases this calculation cannot exceed 90%.  If your home value is $275,000 and your mortgage balance $100,000, then your maximum loan amount would be $247,500 (90% of $275,000) minus $100,000, which equals $147,500.  Discover’s loan range is $35,000-$150,000.

Always be sure to factor in your first mortgage when calculating how much is available to you.

The Rate, Terms and Repayment of a Home Equity Line of Credit (HELOC)

A home equity line of credit is usually tied to a variable interest rate. This means the rate can go up or down over the term of the loan because it is linked to an independent benchmark or index, like the U.S. Prime Rate. As this article was being written, the U.S. Prime Rate was 3.5 percent. As this rate changes, your interest rate will change too, and it is not uncommon for lenders to add a few percentage points to your interest rate in the form of a “margin.” Keep in mind, the better your credit score, the better interest rate options will be available to you.

The term of a home equity line of credit can be as little as 5 or as much as 10 years. All borrowed funds are secured by the value of the equity in your home. This makes a home equity line of credit another good option for making large purchases.  At the end of your loan term, you can no longer withdraw funds and the balance of the loan becomes due.

Because you withdraw funds as you need them with a HELOC, the repayment process requires interest-only monthly payments on the amount of money borrowed. Once the 5, 7 or 10-year term of your loan has expired, you may be required to make a balloon payment to pay off the entire loan balance or the HELOC can become a traditional 10, 15 or 20-year loan. Often, converting a HELOC into a traditional loan enables you to pay off the entire loan amount in manageable monthly payments for up to 20 years.  Home equity lines of credit start at $20,000, and you can usually borrow up to 90% of your CLTV.  Discover Home Equity Loans currently does not offer HELOCs.

The Rate, Terms and Repayment of a Cash-Out Refinance Loan

A cash-out refinance loan is a flexible home equity loan option. With a cash-out refinance loan, you can choose between a fixed or variable rate loan, and the term for a cash-out refinance loan can be up to 30 years.

A cash-out refinance loan is identical to a traditional home equity loan, except you will not have a second mortgage. This is because you are refinancing your existing mortgage into a new home loan for more than you owe, and you take the difference in cash. You should factor in the costs of refinancing when using a cash-out refinance.  Generally, the rate on a cash-out refinance is lower than a home equity loan or HELOC, but there could be more fees and closing costs when refinancing. Discover Home Equity Loans does not charge application, origination, or appraisal fees, and no cash is required at closing.

When you make monthly payments on a cash-out refinance loan, you pay principal and interest, just as you do with a traditional mortgage. By the time your loan term is up, your loan should be repaid in full.

Getting started with a home equity loan is easy! Discover Home Equity Loans has Personal Bankers available to assess your needs and walk you through the entire home equity lending process. To find out how much you can borrow and what rates, terms and payment options apply to your personal situation, contact a Personal Banker today. Click here or call 1-855-361-3435 for more information.

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