Which Home Equity Lending Option Is Right for You?
Whether you want to renovate your kitchen, pay for your daughter’s wedding or consolidate your debt, the right kind of home equity lending product can help you reach your goals. This is because home equity loans come in many shapes and sizes that you can tailor to your needs.
How Much Equity Do You Have?
Your equity is the amount of ownership you have in your home. It is the appraised value of your home, minus the amount you still owe on your mortgage. For example, if your home is worth $275,000 and your current mortgage is $150,000, then you have $125,000 of equity in your home.
What Is a Home Equity Loan?
Simply put, a home equity loan enables you to convert the equity in your home into cash. Most home equity lending products reflect one of the three following structures:
Traditional Home Equity Loan:
This type of home equity loan is paid in installments, just like your primary mortgage. Typically, you can borrow a fixed amount of money and obtain the funds in one lump sum. Traditional home equity loans usually have a fixed interest rate, loan term and monthly payment amount.
Home Equity Line of Credit(HELOC):
This type of home equity loan works a lot like a credit card. You can draw what you need against your equity during a set period of time, and you only pay interest on money you’ve actually borrowed. As you pay back the funds you’ve borrowed, you make that equity available to use again in the future. If your HELOC is an interest-only loan, then you pay interest only during the draw period. Once the draw period has ended (usually 5, 7 or 10 years), the loan may be converted into a traditional amortized loan, or it may require one full balloon payment of the debt.
Cash-Out Refinance Loan:
This type of home equity loan allows you to borrow a fixed sum of money against the equity in your home by refinancing your existing mortgage into a new larger loan. This is because a cash-out refinance combines the borrowed amount with the principal of your existing mortgage. Unlike a traditional home equity loan, you keep only one lien against your property. As you make your mortgage payments, you pay the increased debt over the duration of your refinanced mortgage term.
Now that you know your potential home equity loan options, you need to decide which home equity loan to choose.
How Much Can I Borrow?
Your borrowing ability depends on several factors. These factors include your home value, the lending regulations where you live, your credit history, your income, your debt-to-income ratio (DTI), and the limit on the percentage of your home’s value eligible for borrowing against as determined by your lender.
Talking with a Discover Home Loans Personal Banker is a fast way to determine how much you can borrow, but you can also use our handy loan amount calculator to get a general idea of what amount might be within reach for you.
Once you know how much equity you have, and how much you can likely borrow, consider how you want to use your funds to determine the best type of home equity loan to achieve your goals.
How Do You Want to Use Your Home Equity?
There are many ways to use the equity in your home. Here are just a few common uses:
- Home improvement and renovations
- Debt consolidation
- Big-ticket purchases (like a car or family vacation)
- Finance a wedding
- Pay for school tuition
- Get money for emergency expenses
Home Equity Loan
If you desire to use your loan money all at once, or you prefer the security of a fixed interest rate, a traditional home equity loan may be the best fit for you.
With a Discover Home Loan, you can borrow anywhere from $35,000 to $200,000 depending on your borrowing ability. Your loan is secured by the value of the equity in your home, and you can obtain the funds electronically or by check after closing.
Home Equity Line of Credit
If you desire to use your money as you need it, and you do not mind the possibility of having a variable interest rate, a home equity line of credit might be a good option.
It is important to consider how you want to use the money you borrow. You may not want to use long-term financing options to pay for short-term expenses, like a car or a boat that you may own for just five years. Also keep in mind that your line of credit will only be available for a specified period of time, not indefinitely.
Cash Out Refinance Loan
A cash-out refinance is when you take out a new home loan for more money than you owe on your current loan and receive the difference in cash. For example, if your home is worth $400,000 and you owe $200,000, you have $200,000 in equity. With cash out refinancing, you could receive a portion of this equity in cash. If you wanted to take out $50,000 in cash, this amount would be added to the principal of your new home loan. In this example, the principal on your new mortgage after the cash out refinance would be $250,000. Cash-out refinance loans come with repayment plans up to 30 years.
Now you have a clearer picture of the differences between the different types of home equity loans. Here are some other things to consider
1. What is Your Budget?
Getting a home equity loan to pay for your son’s private school tuition or to surprise your wife with a golden anniversary vacation can feel great, but you must also consider the repayment process. To correctly determine which home equity loan is best for you, you must decide how much you can afford to pay on a monthly basis towards your loan balance.
For most, this starts with evaluating your budget. If you do not have a budget, or if it has become a distant memory, learn how to get your budget back on track. Use our Monthly Payment Calculator to get an estimate of your monthly loan payment and help you plan your budget.
2. What is Your Current Financial Position?
Remember, your borrowing ability will also influence the type of loan available to you. You want to be sure that you select a home equity loan that matches your borrowing ability and financial position. Typically, a borrower should have the following:
- A credit score of at least 620
- A history of responsible credit use
- Verifiable employment and income
- Sufficient equity in your home