Home Equity Loan – What is it and How Does it Work?

Do you own a home that you’ve made payments on for a while? Maybe your home’s value appreciated since you bought it? If so, you may tap into your home’s equity with a home equity loan or home equity line of credit, giving you access to funds tied up in your home.

These loans are a great option for homeowners in need of cash that don’t want the high interest rates or low loan limits of credit cards or personal loans. These second mortgages often have lower interest rates and higher limits, giving you more benefits than consumer loans.

What is Home Equity?

Home equity is the difference between your home’s value and your outstanding mortgage balance. For example, if your home is worth $300,000 and you owe $150,000 on your mortgage, you have $150,000 in equity.

If you were to sell the house today, you’d walk away with $150,000 minus seller fees.

If you want to stay in the home, you can tap into the equity with a second mortgage. Your equity increases the longer you live in the home. As you make payments (either standard or extra payments) and your home appreciates, you’ll earn more equity, which you can eventually borrow.

While you can’t borrow the full amount, the limits are generous, giving you access to the funds you’ve paid into the home.

What is a Second Mortgage?

When you tap into your home’s equity, you take out a second lien on your property or a second mortgage on the home. You have two options:

• Home equity loan
• Home equity line of credit

Both loans provide access to your home’s equity and use your home as collateral. If you don’t make your payments, you put your home at risk.

How Does it Work?

A traditional second mortgage is a lump-sum payment loan, similar to any other loan. You receive the loan’s proceeds all at once, but it uses your home as collateral, just like your first mortgage. You have one interest rate and make fixed payments over a specific term.

A home equity line of credit is a revolving line of credit, similar to a credit card except you use your home as collateral.  You don’t receive the funds in one lump sum (unless you want them). You can take as little or as much of the total loan amount at the closing.

You may then access the funds as you need them via a credit card or check, depending on the bank. If you pay the funds back, you may re-use them (in most cases), just like a credit card. You make interest-only payments during the first half of the term.

HELOCs often have higher interest rates and tougher qualifying requirements than a standard second mortgage because of their revolving nature.

For My Grey Bruce Mortgage and related queries, Let’s connect by calling us at 226-702-0702.

How Much Equity can I Borrow?

Maximum loan amounts vary by loan type. You may borrow up to 80% with a second mortgage plus your existing first mortgage. Using our example above, if you have a $300,000 house with a $150,000 outstanding first mortgage, use the following calculation:

$300,000 x 0.80 = $240,000

$240,000 – $150,000 = $90,000

You could apply for a second mortgage of up to $90,000. You’d receive the entire $90,000 in one lump sum and start making principal and interest payments right away.

HELOCs also allow a loan amount up to 80% between your first and second mortgage like above, but the total HELOC amount itself cannot exceed 65% of the home’s value. Here’s an example:

$300,000 x 0.80 = $240,000

$240,000 – $150,000 = $90,000

$90,000/$300,000 = 30%

This would be within the 65% allowance for a home equity line of credit.

How to Get a Home Equity Loan

Both types of second mortgages require underwriting. You must qualify for the loan by proving your credit score, income, liabilities, and home value.

Home equity loans have more lenient guidelines, serving homeowners with lower credit scores and/or lower income better than a HELOC.

Home equity line of credit loans have higher credit and stricter income requirements because of the ‘revolving’ nature of the loan.

Both loans require an evaluation of your credit score, income, assets, and liabilities. The lender will also order an appraisal to determine your home’s value. This is also how what they use to determine your total loan amount, in addition to ensuring you can afford it.

How can you use a Second Mortgage?

You may use your home equity funds on just about anything. Some common reasons borrowers take out second loans include:

• Get out of high-interest consumer debt
• Make home renovations
• Take a vacation
• Pay for a child’s post-secondary education

Which is Right for you a Home Equity Loan or HELOC?

Most borrowers may choose between the home equity loan and HELOC, but each has benefits targeted for certain borrowers.

A home equity loan serves borrowers with low credit scores or unprovable income the best. You’ll get a set loan amount and know your fixed payments. You can get yourself out of consumer debt, fix up your home increasing its value, or use the funds any other way.

A HELOC is best for homeowners with great credit and that have open-ended projects that may require more funds moving forward. It’s a great option for large home renovations that may take a while and/or you don’t know the ultimate cost. Many borrowers have a HELOC handy for emergencies as well.

Bottom Line

If you have equity in your home near Owen Sound, Ontario, Canada, and would like to use it, call us today. Our professionals can help you determine how much you can borrow and which home equity option is the best choice for your situation. We are available via phone, email, or text and can set up an in-person or over-the-phone meeting to discuss your options.