One benefit of owning your home is that you might qualify to borrow against it, and if so, the interest on your borrowing cost is tax deductible. A “home equity loan” can come in handy when you need funds for home repairs, debt consolidation, college tuition and more.
Second mortgages and home equity lines of credit (HELOCs) are the two main kinds of home equity loans. We’ll take a closer look at each, but first let’s review what home equity is.
Understanding How Equity Works
Home equity is your share of your home’s value minus any outstanding loans against your property. For example, if your first mortgage has an outstanding balance of $400,000 and your home is currently worth $600,000, subtract the loan balance from your home’s value to determine how much equity you have.
$600,000 Home Value
– $400,000 First Mortgage
= $200,000 in equity
In this example, you have 33% equity in your home, meaning you own 33% of the home’s value and the other 66% is financed.
Most lenders will limit the total amount you can borrow for your second mortgage or HELOC so that 10% to 20% of your equity remains untouched. You will build up more equity over time by paying down your loan(s) and/or by your home increasing (also known as appreciating) in value. As your equity increases, you will have more options to access it.
What’s a HELOC?
A HELOC is a second mortgage that functions a lot like a credit card but the loan is secured by your property. The loan has a limit and a revolving line of credit, so you can access what you need as you need it. This helps you control your budget because you only pay a monthly payment on what you borrow when you borrow it. For example, if you’re slowly remodeling your home, a HELOC lets you pay as you go rather than borrowing all the money (and therefore paying all the interest) up front.
HELOCs have a draw period and a repayment period and the total term typically lasts between 15-25 years. During the draw period, you’ll be able to access funds as you need them and each month you’re only required to pay the interest on the amount you owe—paying down the loan balance is optional during this period.
After the draw period ends, the repayment period begins and you can no longer withdrawal funds from the line. During the repayment period, both principal and interests payments are required unless your loan has a balloon payment. If this is the case, all of the funds borrowed are due once the draw period is over.
Rates on HELOCs can move each month, and they rise and fall as the Federal Reserve raises and lowers rates that drive the broader economy. HELOC rates have been very low as the Fed has kept rates low for many years since the 2008 financial crisis, but now the Fed is expected to move into a higher rate cycle in the coming years, and HELOC rates will rise commensurately.
It’s important to talk to your loan advisor to review and understand the fees and how your rate and payment may change over the course of your HELOC.
How Does a Second Mortgage Differ?
One of the main differences between second mortgages and HELOCs is the way that funds are dispersed. Unlike a HELOC, you receive the total amount you borrow on a second mortgage all at once when your loan closes. This is a good option if you have a major expense or home improvement project that requires a large amount of upfront funds.
RPM offers fixed-rate terms for the second mortgages – providing more stability for homeowners who are looking for a consistent payment without any surprises that may come from adjusting rates. Terms are available in 10, 15, 20 or 30 year options, so there is a little more flexibility if you want to stretch out your payments over the course of a longer period of time.
Which Option Will Work For You?
If you’re deciding what loan scenario might work best for you, consider the current amount of equity you have, how much you want to borrow, and what type of payment you’re able to afford. If you need help assessing your choices, contact an experienced loan advisor today who can help you make the most of your home’s equity.