How Home Equity Financing Works: Rates, Terms and Repayment
Home equity products 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 products can be the perfect resource to get the cash you need.
Home equity products available to homeowners. They include:
- Traditional Home Equity Loan: This type of loan allows you to borrow a fixed amount of money in one lump sum usually as a second mortgage on your home in addition to your primary mortgage. With a traditional home equity loan, you can expect to have a fixed interest rate, loan term and monthly payment amount.
- Home Equity Line of Credit (HELOC): This product 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 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 option varies slightly, and each variation offers different rates, terms and repayment options.
How monthly payments can change with different loan terms
Using our loan amount calculator can allow you to enter your home value, remaining mortgage balance, and credit score to see how much your equity and credit allow you to borrow. Additionally, we provide a simple way to see how much your monthly payments would be for a home equity loan from Discover, with breakdowns for the different term lengths of 10, 15, 20, and 30 years.
In general, shorter terms mean higher monthly payments and longer terms will allow for lower monthly payments; shorter terms will accrue less interest charges against the loan than longer terms: meaning that longer term loans will ultimately cost you more.
While the interest rate may stay consistent whether you select a short or long repayment term, spreading the loan out over a longer term will increase the overall amount of interest you will pay against the loan. For example, if you are taking out a $50,000 home equity loan at 4.99% interest, a 10-year repayment term will cost you $530 each month for total payments of $63,600 for the life of the loan. The same amount and interest rate with a 30-year repayment schedule will cost only $268 each month, but you will pay $96,480 against the loan when you complete payments.
Your credit and available equity will typically determine your interest rate offers from lenders, but you will have the ability to select the term of the repayment period. The more you can afford to pay each month, the cheaper your loan will be in the long run.
Rates, Terms and Repayment Options
The beauty of home equity products is the flexibility that’s available to you as a borrower. Because these products offer multiple terms and repayment options, you can choose options 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 products that are available to you.
First, let’s discuss popular 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 5-30 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 product offers different rates, terms and repayment options.
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 Loans offers 10, 15, 20 and 30 year home equity loans in amounts from $35,000 to $200,000.
Discover Home Loans offers 10, 15, 20 and 30 year home equity loans in amounts from $35,000 to $200,000. 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 Loans, your combined loan-to-value CLTV) ratio must be less than 90%. You can calculate CLTV by taking your desired loan amount plus mortgage balance, then dividing that number by your home value.
Always be sure to factor in your first mortgage when calculating how much is available to you.
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 Loans currently does not offer HELOCs.
Rate, Terms and Repayment of a Cash-Out Refinance Loan
A cash-out refinance loan is a flexible home equity 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.