How a Home Equity Loan Works!

Sometimes home equity feels like you're a rock in the middle of a river and the river water is overtaking the rock. Where I'm going with this is, is that whenever you're in your house, you're paying your mortgage on time and you've been there for a while, your home equity just starts swallowing up the rock. And you keep thinking, well, I'm just paying it down and paying it down and paying it down. Well, sometimes people realize, hey, you know what? I actually got like a lot of home equity. I want to tap into this. How do I do that? Let's talk about a home equity loan and see if it's right for you. My name is Andrew Finney, and my passion is helping you make sense of real estate. If you need help finding a top agent near you, or if you simply want to drop me a line, they say hello. My contact info is below. If you're new here, please go ahead, subscribe this channel now and like this video. Thank you. All right, my friend, let's take a closer look at this, because maybe you're like, hey, my home is worth $700,000, but I only owe $500,000 of my mortgage. Where is this other $200,000 and can I get some of it or can I get all of it? Well, in short, yeah, you can. It just depends on how you do that. One way to do that is what's called a home equity loan. A home equity loan is often used interchangeably with what's called a second mortgage. And you might be saying, well, I already have a mortgage. How does that work? And it turns out that you can actually borrow against the equity in your home. And in this case, a second mortgage, also known as a home equity loan, might be an option for you. There are other opportunities as well, and we'll explore them and touch them just a little bit in today's conversation. But for now, let's explore the home equity loan. The first thing to know is how does the home equity loan work? Essentially, a home equity loan can be used to tap into that $200,000 of home equity that you may have from our example we made earlier. So when you're talking about that, the reason that this could be a little bit easier to qualify for is because you're actually putting up your house on the line as collateral. And right there, some people say, hey, you know, right there, if I got to collateralize my house to get that loan, it's not right for me. And yeah, others be like, hey, you know what? I'm OK with this idea of a second mortgage. Tell me more. Well, if that's for you, let's move on to point two, which is knowing the difference between a home equity loan and what's called a HELOC. A HELOC is an acronym for a home equity line of credit. More than likely, you've heard of both of these terms, the home equity loan and the home equity line of credit, often just called a HELOC. And you're probably thinking, well, what's the difference? Well, it turns out they're pretty big. So let's take a look at each one of them. With a home equity loan, you're going to be able to take out a lump sum of cash up front and you'll repay it over time with a fixed monthly payment, kind of like your mortgage. Hence why people often just call it a second mortgage. You're going to have that fixed monthly mortgage payment. Your interest rate will be set on how much you borrow and when you borrow. And it should be remaining a fixed rate for the life of the loan. You want to review that, of course, with the loan officer that you take this out with. Each monthly payment will reduce your loan balance and cover some of your interest costs, which is oftentimes referred to as simply amortizing the loan. Now, with a home equity line of credit, you don't receive the lump sum at one time. Essentially, what this option will let you do is let you borrow from it multiple times the same way that you could with a credit card that you probably have in your wallet or your purse. Now, I would caution you to be careful as using your home equity as a credit card. All the same, this does better define the difference between the home equity line of credit, a HELOC, and a home equity loan. Home equity loan, think of it as a second mortgage that you're going to be paying monthly installments on and you're getting a big lump set of cash back to you for the home equity portion. Whereas a home equity line of credit, well, you just tap it into your home equity, kind of like a credit card. And it is important to remember that with a home equity line of credit, that a lender could actually freeze your credit the same way that they could do with your credit card. So you want to make sure that you're making the decisions that are right for you and reviewing your options. If you're considering either one, a HELOC or a home equity loan with the loan officer that you choose to proceed with, make sure that you understand all the terms and all the conditions and what happens with it over time. The third thing that you want to know is what are the repayment terms and plans available to you for the home equity loan? You want to know what you're locking yourself into. Going back to when I said a moment ago, it should be a fixed rate. Well, what happens if a loan officer offers an adjustable rate? Do you really want that? You need to explore these terms and make sure that you understand what you're doing up front and the reasons why you're interested in tapping into your equity. As a professional, I always believe it's best not to tap into your home equity unless you absolutely need to or there's a reason for it. A desire that you might want to go out and buy a Rolls Royce is not generally a good reason to tap into your home equity. So if you have medical bills or you have situations where you have grandkids or kids or yourself going to college and you want to pay off your student loans, OK, balance out the interest rate, see if it's going to be right for you. All at the same time, make sure that whatever you choose to do with your home equity and with your house, you're making a well-informed decision that's right for you. Only way to do that is to dig into those details that are oftentimes boring and sometimes cumbersome, but all too often so important to us. Because if we don't make good on what we agreed to, ignorance of what those terms were isn't going to hold up and we're going to be on the hook with that decision that we made. And we might look back, our future self might look back with 20, 20 hindsight saying, hey, I wish I would have done that or, hey, I wish I would have asked this extra question. That's why we're having the conversation now. So let's take a look at three of the pros and three of the cons of the home equity loan. One of the pros of a home equity loan is that you can claim a tax deduction for the interest if you pay it to use the loan to buy, build or substantially improve your home. So when sometimes people ask, what are the different types of loans I could take for home improvement, a home equity loan could technically be one of those. Now, of course, I'm not a tax advisor. The second pro is that you'll probably pay less in interest than you would on a personal loan because a home equity loan is secured by your house. So you could get a lower, potentially a lower interest rate. Now, all the same, you want to know exactly how that works and keep in mind the devil's in the details. Right. Just said that this type of loan is secured by your house, which means if you don't make good on it, could lose your house. The third pro is that you could borrow a lot of money if you needed to, depending on how much equity is in your home. But everything that's good, there's always some other things that we need to see on the backside of that coin and make sure it's a good thing. So let's take a closer look at the three cons that you need to be aware of. The first one is that you could risk losing your house in a foreclosure if you weren't making your payments on time. Keep in mind, this is why a home equity loan is often called a second mortgage. You're securing a home equity loan with your house. So you have a first mortgage and a second mortgage. If you don't make good on either one of them, you could potentially be foreclosed upon and lose your house. Generally, for reference, if you miss three months of mortgage payments, you risk initiating a notice of default situation, which is the first step in a foreclosure proceeding. Please make sure that you completely understand what you're doing here. The second one is that you'll have to pay this debt off immediately and in full any time that you get ready to sell your home, just as you would with a first mortgage. So when you meet with a trusted real estate advisor to review your listing options, they're going to ask you, how much do you owe on your mortgage? You're going to have two mortgages that you need to share with them so they can balance out what's called an estimated net sheet and show you about how much money you should be able to walk away from after you sell your home. Obviously, we need to make sure that the market trends, indicators and conditions are right for you to recoup the cost of tapping into your home equity loan. And the third thing is you're going to have to pay a closing cost. So unlike with like a home equity line of credit, where it's essentially like a credit card with a generally variable rate, the way a lot of credit cards are too, right? So with a home equity loan, you're actually going to have closing costs, home equity line of credit, not so much, but always review the details with the loan officer, whether you're choosing a home equity loan or a home equity line of credit. Make sure that you're making the right decision for you, please. The fourth thing is how do you get a home equity loan? Well, you could go back to the same person that assisted you with the current home that you have. You can obviously go on the Google and simply type in home equity loan providers and see what's going on with them. Check their online ratings, check their online reviews and check out what other real families, just like you were saying about them to find which ones that you want to contact. Go ahead and apply with some of them if you're serious about pursuing this option so that you can review the loan estimate. I'll go ahead and pop up a card about loan estimates now so you can take a closer look of it and make sure that you know how to understand the loan estimate and what you need to be looking for. What you can do is check those rates, check those terms, ask the questions that are in your mind's eye about the home equity loan and how that company will work moving forward with this type of a loan. The fifth thing to know is what if you have poor credit? Can you get a home equity loan? It's quite possible. It just depends on how bad your credit is. Now, obviously, hopefully you had at least a 620 or 640 when you purchased your home. But we all know that life happens. Sometimes things set us back. Sometimes someone gets sick. You can't work. You can't pay a bill on time and your credit score takes a hit. Well, what happens if you need to tap into some cash for an emergency type situation? Right. First of all, it's not exactly the best idea to tap into your home's equity. It would be better, frankly, to sell the house and downsize into something that's more financially prudent for you. All the same, this is your life. It's your story. You've got to plan this out in the way that you believe is best and right for you. That being said, if you have a low credit score, will you be able to get a home equity loan? Only one way to know for sure is to contact that loan officer. More than likely, depending on how much equity is in your home, that loan officer may give you the loan because they're going to collateralize your house and they know they can foreclose on you and get their money back because your home equity loan is associated with your house. And it's your house, the roof over your head that's on the hook here. If you don't make good, they know that. So they're like, hey, if you're going to be a riskier investment, great. You're going to get a higher interest rate on the front side of this. And oh, by the way, we're going to go ahead and take your house if you don't make good and you miss three payments. Make sure that you're making a smart move here. As a side note, please keep in mind that you're still going to have to go through the mortgage application process here and you're going to have to have your debt to income ratios evaluated like you did whenever you purchased your home. They're going to verify your income, your assets, your credit and your employment situation to ensure that you have the financial ability to repay both the first mortgage and the second mortgage, in this case, being the home equity loan. The sixth thing to know is how the loan to value ratio will factor in here. A loan to value ratio and lender speak is LTV, right? What does this mean exactly to the rest of us? Well, loan to value ratio is how much loan you have out as a factor of percentage to the value of your home. Let's say that you have a $1 million home and you have an 80% loan to value ratio. That would mean that you have 200,000 in equity, that $200,000 and the 80%, right over here would be how much home loan you have on that $1 million house. So this is what's called an 80% loan to value ratio. So obviously lenders are going to have some criteria here. And depending on what your credit score is, will depend on how much you can tap into. Generally, lenders are going to be looking for you to at least have loan to value ratio of 80% and they might only lend up to that point, leaving that 20% untouched in case. Why? Because they need the foreclose on you. They want to make sure they can recoup their costs. So the best way to know exactly how this is going to work for you is to chat over your home equity loan options with the loan officers of your choice. Make sure that you ask them these questions and make sure that you're clear on their answers so that you can make the best decision possible for you. The seventh thing is to beware of the red flags. There are certain red flags that stick out that a lender may not be the best fit for you or may not be as reputable as some of the other home equity loan providers. Let's take a closer look at each of these flags. The first red flag is the lender changes the terms of your loan, such as your interest rate, right before you close under the assumption that you won't back out because it's too late to back out now, even though in reality you could. But they're going to make the assumption that they're going to try to change something in the term. This isn't cool and don't get the wool pulled over your eyes. The second red flag is the lender insists of rolling on an insurance package into your home equity loan. You can usually get your own policy of insurance if this is required. So make sure that you're very clear on what type of insurance it is and what type of insurance is being provided here and see if you really need it or if it's going to be cheaper for you to get your own insurance on your own here. The third thing is the lender is approving you for payments that you really can't afford and most importantly, you know in the bottom of your heart and your mind's eye, you know for a fact you can't afford that payment. There is a difference in how much someone can get potentially approved for to buy a home or tap into their home equity and then the reality of having the financial capability and affordability to do just that, afford it. Please make sure that if you know you can't repay it, that you don't move forward. So don't get wooed by the thought, oh, I can get $200,000. I'll be able to just put this on the side. Okay, for how long? Let's play this out to the next logical step here. How long are you going to be able to play that game before it's going to catch up to you? Let's be honest here because we don't want you to get hurt. If you know you can't afford those payments, don't proceed with the option. Please make the smart move for you. The eighth thing that you want to do is to explore the alternatives to the home equity loan. You could do a cash out refinance, which is going to be able to give you the money that you want, but you don't have to tap into all your home equity at one time. A cash out refi, people always think, oh, I'm just going to tap into all my equity. Well, you could, but you don't have to. And it goes back to what we were just discussing a moment ago. Make sure that whatever you do here, you have the true financial ability to truly afford repaying it back. So you don't get yourself in a bad position and lose your house. I'd hate for you to say, Andrew, I lost my house because I did this. Well, if you're having this conversation with me right now, that should never be your case. And as many people as you share our conversation with and you ask them to watch this too, if they're thinking about it, guess what? We can help each other. We're always stronger and better together than we are not. Let's spread the word and inspire positivity and dispel any negativity out there from people making poor decisions. By education, we can increase the knowledge and the power of each of us so that we don't fall prey to those that just want to make a quick buck and let you run away with the green. Let's be honest there. I mean, it's people's internal greed, their internal desire for that money that causes these problems. Well, we need to make sure that we make balanced decisions. It's your life. It's your story. Let's get it right because we only get one shot and our story is going to take the form of the decisions that we make each and every day. The second thing that you could do is a reverse mortgage. Now, a reverse mortgage specifically goes for people that are age 62 and older. Now, they might want to review their options of how a reverse mortgage is going to work for them with a loan officer. Please, if you're considering a reverse mortgage, do your homework and make sure that you understand how that's going to work and what happens to you when your time comes and you go on to the next life. Let's make sure that you are setting up your family for success, living with what you need for success, and that you understand the details of how that reverse mortgage is going to impact you. All right, my friends, so now that you know more about the home equity loan, let's take a closer look at how a home equity line of credit works and when refinancing is a good idea. Looking forward to our next conversation. We'll see in a few.