This post is a response to Saundra Latham’s great article about the best home equity loan rates for 2016 (US), posted on the The Simple Dollar.
Paying off a mortgage results in more than just owning a home. The value of your home is a form of savings that provides negotiating power for other loan arrangements or investments. For many people, the downside of making regular mortgage repayments is the lack of ready cash or additional savings potential. A home equity loan can provide the solution, by allowing home owners to borrow money against the value of their home. This money can be used for any number of home improvements or other purposes.
Owning a home remains an achievable ideal for most Australians. Values have soared, but it’s worth noting that many sought-out neighbourhoods were fairly humble settlements just a couple of decades ago. Interest rates also remain low, often at 4% or less, providing lower repayments and a positive outlook for prospective home buyers.
The initial climb onto the property ladder can be slow, but wages do incrementally rise, and every passing year sees an increasingly large chunk of the outstanding loan principal paid off. During this time, the value of your home (investment) will significantly increase, and maintaining that investment could involve an injection of serious cash. A home equity loan is the answer.
What is a home equity loan?
Firstly, home equity is calculated as the amount you owe subtracted from the value of your home. In other words, if your home is valued at $400,000 and you owe $100,000, your home equity is $300,000. This is potentially the amount you could borrow, taking into consideration your ability to make repayments for the term of the loan.
The rules governing home equity loans in Australia are relatively simple. If you have commenced paying off a mortgage and possess over 20% equity on the property, you have a good chance of a home equity loan approval. The amount you can borrow is also determined by factors such as income and personal finances. Any encumbrances on your property could also affect the application.
What is a closed-end home equity loan?
A home equity loan can be either closed-end or open-ended. A closed-end loan is ideal for making a single purchase with a set amount of money. In essence, a closed-end loan is a lump sum payment with similar conditions to your initial mortgage, and is often used for major home renovations. An open-ended home equity line of credit (HELOC) is best if you require ongoing funds that are available to replenish and redraw upon, similar in function to a credit card but with greater borrowing power.
Home equity loan benefits:
- Less processing time
- The money can be used for almost any purpose
- Competitive interest rates
- HELOC loans facilitate deposits and withdrawals for ongoing access to funds
Is a home equity line of credit considered a lien?
A lien is the legal right of one person to claim the property of another person. In other words, if loan repayments are not made, the bank or lender is entitled to sell your property and recover funds. A home equity line of credit is considered a lien on your property.
The lien related to your home equity loan will depend on the way you wish to spend the money. If your home equity loan is solely for refinancing your existing mortgage, for example, to take advantage of interest rates, it will be a first lien mortgage. If you take out a home equity loan while you still have a first mortgage, and the loan is used for a purpose other than refinancing, it will become a second lien loan.
Is a home equity loan the same as a mortgage?
For most intents and purposes, a home equity loan functions in the same way as a mortgage. The money borrowed is paid back in regular instalments until the debt (including interest) is repaid. In fact, a home equity loan can be totally absorbed back into the mortgage as part of a refinancing arrangement.
A HELOC loan provides the additional flexibility of drawing on funds from the loan when required. The loan can also be topped up and redrawn on repeatedly without additional fees, as long as interest is paid on schedule.
Additionally, and most importantly, a home equity loan finally puts you in control of the ready funds. It’s your choice to build, renovate, invest or even spend a little on a well deserved vacation. A home equity loan is a serious obligation, but can also be a sign that your finances are in good shape and it’s time to live a little.