A Layman’s Guide to Home Equity Loans

Outlining the clear benefits and risks for property investment beginners

By Heather Sanchez

Home equity loans are secured loans that require your home be put up as the collateral security. As a person who’s been involved in real estate investing for many years, I’ve used them to personally finance the renovations in order to flip and sell a property, as well as to secure a home equity loan on one property in order to finance the purchase of another property.

There are a many benefits to home equity loans over other loans, for instance:

• Home equity loans are advantageous for both the consumer and lender

—there is little risk to both as long as you can pay the monthly loan amount, and lenders feel secure because your home asset is the collateral

For this reason lenders are more flexible about the terms and conditions because of the loan’s secure nature

The home owners can utilize the home equity loan for any purpose they want—for example, to pay off personal debt, debt consolidation, home renovations, and even to pay medical bills

The monthly repayment on a home equity loan tends to be cheaper

Credit score aren’t as highly considered for the securing a home equity loan due to the fact that the security of your home is the risk

Most home equity loans are quick to process—approximately 5 business days to secure. The way a home equity loan is structured is also advantageous compared to other loans. Due to the fact that these are fixed loans, the repayment period tends to be longer (i.e., 10 years to 30—depending on the loan amount), and most lenders will offer the maximum amount due to the fact that they can garner more profit from it. You will be granted a home equity loan based on your current mortgage, meaning the loan amount is based on both the volume of the equity you owe in the home (or the outstanding in the mortgage) as well as the current market value of your home. Usually an assessment of your home is necessary in the loan approval stages. 

To secure a home equity loan with a lender

• Fill out a home equity loan application with your bank or financial institution
• You must provide proof of home ownership—via a title search
• As well as the current equity in the home (this is often done with a drive by assessment) as well as based on the type of home you own—obviously a single-family home would garner a larger loan amount than say a condominium or modular home
  
• You must provide proof of employment via pay-stubs or a letter of employment from your current employer, the last years of income tax statements can also be used as testimony
• All of this information is used to judge your debt to income ratio (or your ability to pay back the loan).

The risk of a home equity loan

For the home owner, the obvious risk to an equity loan is your ability to make the repayments each month, on time. If you fail to do so, the bank will repossess your home.

About The Author

Heather is a staff writer for Lifestyles Unlimited where she has been involved in Houston real estate investing for several years. She enjoys analyzing investment trends, laws, and practices while at the same time debunking any myths she may find. As the owner of multiple rental properties and “flipped” houses, Heather believes that Real Estate Investors help put money back into the North American economy.

Reasons Not to Fund Major Home Repairs With a Second Mortgage

A second mortgage should not fund major home repairs because it can 1) increases overall debt to income ratio, 2) lower credit rating through increased debt 3) increase monthly budget costs due to interest on the second mortgage, 4) potentially reset a mortgage amortization schedule so less money is paid into principle every month and 5) may not pay off in an increase in equity value of the home.

In a sense second mortgages can be compared to credit cards with large credit limit and a lower interest rate; the larger the amount of the loan, the higher the total interest owed will be. If a household cannot afford home repairs using existing finances, and is already heavily in debt then the home repairs could be a risky gamble. To illustrate how a second mortgage can be an overextension of debt and a financial risk in addition to the above points are the following three points.

• Financial burdens too high for the borrower may be facilitated by the second mortgage.

• The sales price to mortgage risk ratio may be too low. (www.mrgprofessor.com)

• Bankruptcy may be just around the corner in the event of income interruption.

Alternatives to a second mortgage

While home repairs may be a necessity rather than a profit driven action, a second mortgage may seem like the only option. This is not the case. Second mortgages are an implicit indication of living beyond one's means. If home repairs are too expensive, mortgage holders may be wise to consider the following options. These alternative options can save money on interest accumulated and owed through the second mortgage and lower one'soveralldebt if the alternative involves upfront or short term payment.

• Financing a repair with a contractor.

• Save money for the repair.

• Sell the home as is and buy a smaller home in better condition at the same rates and monthly costs.

• Cut costs to finance the repair.

• Obtain an additional source of income.

• Ask for a tax deductible gift from a benefactor.

• Shop around for a low cost but licensed and fully insured contractor.

The opportunity cost of second mortgages

There is yet another group of people who may still not be convinced second mortgages are a bad idea. People who are banking on their own revenue stream and the benefits of the mortgage may think the second mortgage is a worthwhile risk. It is not worthwhile because of the opportunity cost. Money invested in a home repair is money not invested in 5% certificate of deposit or retirement savings plan.

The opportunity cost of investing in a home repair outweighs the benefit of the home repair itself.

For example, a $20, 0000 second mortgage at 6% annualized interest costs $1,200.00 per year to finance. The same $20, 000.00 in an IRA earning 9% earns $1,800.00 per year and if it is in a CD at 6% $1,200/year. In 5 years the CD would yield $6,000 or closer to a third of the face value of the mortgage and or home repair cost. In other words, if the home repair isn't essential the money is better spent elsewhere.

That's not all, many home repairs can be temporarily fixed with a less expensive measure. For example, major roof repairs can be patched, and foundation cracks can be sealed, While this is not a solution to the problem, it can buy time to save enough money and/or cut costs long enough to finance the repair. For repairs that are absolutely essential and must be completed, 2nd mortgages are not the only sources of financing. Other sources include the following:

• Home Equity Line of Credit.

• Loans against Insurance policies and IRA's.

• Automobile financed loans.

In other words there are more options that may not be as risky as loans against life insurance and IRA's are secured and losing an automobile is better than losing a house in the unfortunate scenario of the loan falling through. What's more home equity lines of credit do not require all the money be used. A home equity line of credit could be used to finance the home repair over time.

In sum, second mortgages can be risky and are not always even a profitable decision. When it comes to home repair, home repairs can be dealt with in many ways and one should not always think a second mortgage is the best and only way to finance a home repair. The above article elaborates on these reasons and illustrates other sources of financing and problem solving while stating and illustrating reasons why major home repairs should not be funded by second mortgages.

Source: http://tinyurl.com/6a9tchn ('The Mortgage Professor')

Pros and Cons of Paying Off Credit Cards With Home Equity Loans

Equity costs less than credit so financing a credit card debt with equity is cheaper. However, there are a few cursory related issues such as capital for home improvements, amount of credit card debt, and refinancing that can make the interest rate benefit not worthwhile.

This article will discuss the various advantages, disadvantages and factors that may assist with the decision to pay off credit card debt with home equity, and then follow up with a few tips that may prevent one from having to use home equity to pay off debt.

Advantages

The larger the credit card debt, the more practical a home equity loan becomes once all other options are deemed unavailable. In other words, if there is no other cost saving solution, a home equity loan may not be such a bad idea.

• Net Gain on Interest Rate Savings: Equity loans and lines of credit cost in range of 5-8% in interest whereas credit cards charge between 9-20% in compounded interest. Depending on the amount of credit card debt one has, this can make a significant annualized difference in savings. For example, if an individual has $7,000.00 of credit card debt at 14%, the nominal non-compounded interest for one year would be $980.00. At 6% through a home equity loan, that amount would be closer to $420.00 nominal i.e. non-compounded.

• Enhanced Individual Cash Flow: With less debt tied up in credit cards, monthly expenses go down all other expenses held constant. This can place one in a better standing with credit card companies and allow for more cash flow with which to manage monthly costs.

Disadvantages

Since homes are often a source of financial security for individuals and family, utilizing the equity in one's home can be a drain on financial assets that may be needed in the future.

• Refinancing causes Re-Amortization of Mortgage: When a mortgage is refinanced to include a second mortgage via a home equity loan, the mortgage amortization schedule can reset meaning the interest payments will likely rise in proportion to capital contributions. The difference between the newly amortized repayment terms and the savings from paying off the credit card debt may be too low to consider.

• Equity leveraging Declines: Should the need arise for a home improvement emergency or unexpected family cost, one may have be required to resort to credit cards once again making the equity loan redundant. In this case, one should assess the potential for future expenses and individual savings and cash-flow to assure the equity loan doesn't use up too much leverage.

Tips on using equity to pay off credit cards

• Negotiate Credit Card Rates First: One may be able to lower the credit card interest rate through credit counseling services or directly with the credit card company. This can save one's home equity and monthly expenses.

• Finance Large Debt: If the debt is large, the potential savings increase than with smaller debt. It may not be worthwhile to take a home equity loan for small amounts of credit card debt.

• Vehicle Collateralize: In some instances, a newer or luxury vehicle can be used as collateral for a loan with more favorable interest rates than credit cards. By considering a vehicle collateralized loan, one can save with a lower interest rate and protect the equity in one's home.

Home equity loans can be a good idea, if the financial circumstances deem them necessary to cut costs and save money. However, it is important to note such loans may not be worth the effort or the cost after mortgage recalculations, unexpected costs requiring future credit card use.

The primary factors one may think about prior to obtaining a home equity loan to pay off credit card debt are the size of the debt, the potential cost savings, future cash flow needs and other lower cost sources of financing the credit card debt pay-off. Should the equity loan still be favorable after such factors are entered into the equation, the loan may be worthwhile.