The best advice for homeowners contemplating a home equity loan: Tread carefully.
Home equity loans, sometimes called second mortgages, can be a cheaper source of cash than say, credit cards. At the same time, you’re taking on another debt and using your home for collateral.
Although the go-go, pre-bubble days when homes were big sources of cash are gone, home equity loans are percolating, says Aaron Bresko, vice president of consumer lending and underwriting for the Boeing Employees Credit Union.
Because interest rates are up slightly and expected to increase, homeowners are turning to home equity loans while retaining their low-rate first mortgages.
When rates are falling, refinancing becomes more popular because it gives homeowners a chance to negotiate a lower interest rate and cash out some equity at the same time.
As the mortgage and refi business slows, home equity loans are picking up at BECU, Bresko says. “And I don’t see that slowing down,” he adds.
Are you borrowing money to pay off existing debt, or are you taking on new debt?
Taking a pile of unsecured debt, such as credit cards, that you’re already having trouble paying, and converting it to secured debt by pledging your house as collateral is not a savvy financial move and one that’s more likely to be an anchor than a lifeline.
Getting a lower rate to consolidate debts? Not so fast, says Rheingold. “The reason you’re getting a lower interest rate is because you’re securing (the loan) with your home. Why are you doing it, and what are your alternatives?”
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Remember: Competition drives down fees
As with a first mortgage or a refi, you’ll face a menu of fees for a home equity loan. You can shop fee-free loans like you can with a first mortgage, which gives you an apples-to-apples way to compare costs.
Either way, expect lenders to be going light on the fees, says Bresko.
“More and more, to be competitive, you see less and less of the fees,” he says. “It’s quite a change.”
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Your loan-to-value ratio is important
You might think that because you’re borrowing home equity, your home’s value is the only number that matters. It’s not.
Your loan amount compared with your home value is important. It’s called the loan-to-value ratio, or LTV, and different lenders will have different requirements for this one.
Having an idea of how much you want to borrow and what your home is worth will help you shop.
Before you apply for the loan, ask the lender what LTV ratios the underwriting department likes to see, especially for the deal you want. If your question is brushed aside or your lending rep doesn’t know the answer, ask to speak with a manager or someone from underwriting.
Work your way up the food chain until you get someone who will fill in the blanks.
The nitty-gritty of home equity loans: Lenders are more likely to lend if the house you’re borrowing against is your primary residence. If it’s an investment property, you may still get the loan, but you’ll have to have more equity and the interest rate could be higher, says Bresko.
Lenders will approve a home equity loan if you have really good credit and 10 to 15 percent equity in your residence.
If the home securing the loan is an investment property, lenders want to see the same good credit, plus at least 30 percent equity, “because there’s more risk with investment property,” says Bresko.
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Make sure the loan is affordable
Your financial life won’t always run smoothly. Job loss and family emergencies can change your cash flow overnight. So, if you’re negotiating a loan that uses your home as collateral, be sure to build in some wiggle room.
“People need to be sure they can afford the loan,” says Sarah Wolff, senior researcher for the Center for Responsible Lending. “That’s true with any loan, but especially when the loan is tied to your house.”