What is your best home equity loan option?
Whether you want to renovate your kitchen, pay for your child’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?
If you want to use your home’s equity to finance a loan, there are three basic options: home equity loans, home equity lines of credit (HELOCs), and cash-out refinance.
Similarities between home equity loans, HELOCs, and cash-out refinance
All types of home equity financing generally boast competitive rates. Using any of these funds towards home improvements can sometimes earn you tax deductions, for the interest you pay against the loan each year (see a tax advisor to see if you qualify). Also, all home equity financing allows you to use the funds for most expenses. Each of these home equity options depend on your home’s assessed value and require you to have equity in your home. The value of your home and your outstanding mortgage debt are key factors in determining your maximum loan amount, as are income and credit score. All of these factors figure into your potential approval for home equity financing.
Differences between home equity loans, HELOCs, and cash-out refinance
Home equity loans are the most straightforward of these home equity financing options, where you apply for a specific loan amount and, if approved, begin repaying the loan at a fixed interest rate until the loan term expires or you have paid off the loan balance.
HELOCs are flexible in both the amount you withdraw and the interest charges against what you withdraw. Instead of receiving a lump sum of the full loan amount, you will gain access to a credit account that contains the maximum limit of your HELOC. As you need the funds, you can transfer those funds into your checking account, write checks from the HELOC account, and for some HELOCs use a card to access funds. Whatever amounts you withdraw during this draw period is charged interest. Some HELOCs allow you to pay only the interest payments during the draw period. When the draw period ends, you must begin paying both the principal and interest against what you have withdrawn. Some HELOCs may use variable interest rates, which mean that the rate can move up or down, depending on the index used (prime or LIBOR generally) plus the margin provided with the loan. Given this, monthly payments for HELOCs over the life of the loan may increase or decrease.
Cash-out refinances are similar to a home-equity loan and replaces your existing loan on your home with a new loan and extra cash. Generally, when refinancing, borrowers typically look to lock in lower interest rates or change the repayment terms (making terms shorter to earn lower rates and pay off the loan sooner, or making terms longer to reduce monthly payments). With a cash-out refinance, the new mortgage loan is for more than what you owe on the existing mortgage. The difference between the entire amount of the newly refinanced loan and what you owe on your mortgage is paid to you in a lump sum. One thing to keep in mind with cash-out refinance is that there may be fees with the loan, which may be between 3 and 5 percent of the total loan. Discover® Home Loans offers a mortgage refinance with low fixed rates, loan amounts ranging from $35,000 to $200,000, and zero charges due at closing.
|Pays off primary mortgage loan?||Interest rate type||Payout||Repayment term||Qualifications||Loan amount based on
|Home equity loan||No||Fixed||Lump sum||5 to 30 years||Home equity, income, credit score||Combined Loan-to-value ratio of the amount borrowed vs. the value of your home and ability to repay.|
|Home equity line of credit||No||Fixed or Variable||Withdrawals as needed during draw period
||10 to 20 years, following draw period|
|Cash-out refinance||Yes||Fixed or variable||Lump sum||Up to 30 years|
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
How Much Can You 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. Combined Loan-to-Value Ratio (CLTV) will also play a factor. The CLTV is calculated by taking your current mortgage balance plus your potential home loan amount, then dividing that number by your home value. The lower the CLTV, the better. 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 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
Is a Home Equity Loan Right for You?
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 Rate & 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: