As we enter the New Year there are many changes happening in the financial sector to consider when creating your financial plan for 2017. A new administration will be settling in and with it there are likely to be policy changes that will potentially impact the financial markets, including the banking industry. We’ve seen a quarter point increase in the prime rate and it’s likely that there will be an additional rate hike in 2017. Some effects of these changes will be long term but the short-term effect is likely to be an increase in the cost of borrowing capital. Our blog this month comes to us courtesy of The Simple Dollar at the hands of veteran financial author Saundra Latham.
Best Home Equity Loan Rates for 2016
Find out if a fixed-rate loan or home equity line of credit is best for you.
By Saundra Latham
A Crash Course in Home Equity
Many people will eventually find themselves in the position of needing to acquire a large sum of money, whether it’s for a home renovation project or an unexpected expense. For many, the answer is to turn to a home equity loan, but with so many different options and a rather confusing and difficult process, it can be very overwhelming. To simplify the process, The Simple Dollar, a website dedicated to helping people simplify all aspects of their financial lives, created a www.thesimpledollar.com/best-home-equity-loan-rates/. Armed with expert reviews, detail comparisons, and data-driven research, their team put together an overview of finding a home equity loan from start to finish. Here are some tips from their article to help you decide if a home equity loan might be the right choice for your finances.
What is a home equity loan?
Home equity loans let you use one of your biggest assets — your home — to help you borrow cash more easily. You’re using your home’s equity (the difference between what your home is worth and what you owe on it) as collateral to lessen the risk the lender takes on when they make the loan. Because the collateral holds such high value, you can get a lower interest rate than you may be able to get on a credit card or an unsecured personal loan.
How much can I borrow?
Today, most lenders will calculate 80% of your home value, then subtract what you owe on your mortgage or any other home loans to figure out what you can borrow.
For example, if your home is worth $200,000, 80% of its value would be $160,000. If you have $100,000 left on your mortgage, your lender will subtract that from $160,000. That means you’ll likely be allowed to borrow a maximum of $60,000 for your home equity loan.
A decade ago, it was common for lenders to allow you to borrow as much as 125% of your home’s value minus your mortgage balance, but standards have tightened since the subprime mortgage crisis. Though that might keep your loan smaller than you’d like, it also cuts your risk of default by keeping you from borrowing more than you can repay.
Pros and cons of home equity loans
Home equity borrowing sounds great, and it certainly has perks. However, there are also some very real risks to consider, even with the best home equity loans. Here are some pros and cons:
Pros
Low rates: Because your home is collateral, you won’t pay as much in interest as you would with an unsecured loan with no collateral. This also makes it easier to land a home equity loan with a reasonable rate than a personal loan or credit card if your credit isn’t top-notch.
Tax benefits: If you itemize your deductions, you can deduct the interest you pay on the first $100,000 of your home equity loan.
Access to a large sum: Depending on the amount of equity you have, you may be able to access more cash with a home equity loan than with other borrowing options, including credit cards or personal loans.
Flexibility: Whether you need money for a big expense like home renovations or an unexpected financial emergency, you can usually use your home equity loan for any purpose.
Cons
Your home is at risk: If you suddenly can’t repay your loan, your lender can take your house.
You could go “underwater”: If your home’s value declines after tapping its equity, this may leave you owing more on your home than it is actually worth. This is called being “underwater” or “upside down.” Since the 2008 subprime mortgage crisis left many homeowners underwater, lenders have tightened their standards, but they can’t eliminate this risk entirely.
Closing costs and fees can be pricey: Some experts refer to home equity loans as a second mortgage. The cost of closing your loan can be expensive, up to 5% to 6% of your loan, just like a primary mortgage.
It’s still debt: Low interest rates and large sums make home equity loans a tempting way to pay for things you may not truly need, but it’s not a wise idea to tap your equity for nonessential purchases or frivolous home improvements. You’re essentially taking a chunk of your net worth and converting it into debt. You’ll need the discipline to pay off the loan and keep your spending in check, too. Remember, home values can and do fluctuate. Prepare for this by not taking too large of an equity loan against your home.
If you tap your home equity for a clear purpose and are confident you can repay the money without difficulty, a home equity loan might be a good choice for you. If you want money fast for a frivolous reason or can’t comfortably afford another payment, you should definitely think twice.
Just like your primary mortgage, a home equity loan is a serious business. For responsible borrowers, it can be a great tool, but if you don’t plan ahead your home could be on the line.