If you are potentially looking for buying a home, you might have heard the term ‘home equity loan’ a few times.
Home equity is the difference between the market value of your home and the amount that is owed to the moneylender who holds the mortgage.
The equity is the money that you will receive after paying off the mortgage if there is circumstances arise to sell the home. Home equity loans also help you to raise money against the value of your home.
People take out home equity loans as it enables them to raise money without selling it. So, if you are a first-time borrower and want to buy a home then this guide will show you the right way.
Here, in this article, we are going to discuss what a home equity loan is and how it works, where to get a home equity loan, how to pay off a home equity loan, how to finance a home equity loan and the pros and cons of a home equity loan.
So, let’s dive right in and gather the right information about it!
Home Equity Loans, What and How it Works?
A home equity loan is a type of mortgage that can help you to finance a home. The loan is directly linked to the value of the asset; in this case, a property. A home equity loan is a category of consumer debt.
Home equity loans enable homeowners to borrow money against the equity in their homes. The amount of the loan depends upon the home’s current market value and the homeowner’s mortgage balance due.
Home equity loans tend to be fixed rate and lenders will borrow you the money against the value of your home.
When you first purchase a property, the equity amount that you hold will be equal to the value of your deposit. Then when you pay back the principal amount gradually, your equity will increase.
But, it is not the only way to boost your equity, it will also increase when the value of your property increases over time. So, you can understand that there are two ways to boost your equity. One is under your control and another one is more dependent on external factors in the property market.
A home equity loan also refers to a second mortgage. The equity in the home act as collateral for the lenders. The amount that a homeowner can lend will be based moderately on a combined loan-to-value ratio of 80% and 90% will be based on the home’s appraised value.
But, the amount of the loan and rate of interest will vary depending on the borrower’s credit score and payment history.
A home equity loan can be a good way to convert the equity that you have built up in your home into cash. If you invest that cash into your home’s renovations then it can lead to an increase in the value of your home.
Where to Get a Home Equity Loan
You can get a home equity loan from banks, financial institutions, or building societies operating online only. But, they are harder to find out than looking for a standard banking product or an unsecured loan.
Most of the biggest UK banks don’t offer home equity loans at all. Whenever you look for borrowing, you must consider legitimate lenders that are authorized and regulated by Financial Conduct Authority.
Here we are going to provide some of the trustworthy home equity loan providers. This list may help you to get your home equity loan. But, before proceeding ahead, you must research the lender you opt for.
Some of the trustworthy home equity loan companies are-
- Bank home equity loans:
While searching for a home equity loan then banks may be the first place you think to look. Many UK banks offer these products so you can easily find out your preferred place. Barclays Bank offers home equity loans whereas HSBC currently doesn’t offer any loan on a mortgage.
- Online home equity loans:
You can get online home equity loans through online lenders including companies advertising themselves as an online bank. Searching online helps you to come across various companies, some of which you may have not heard of before. But, you need to be sure to apply to the UK lenders only.
- Building society home equity loans:
There are a few building societies that offer home equity loans, you can get them through bigger and more well-known building societies. These building societies are more focused on releasing equity in later life rather than simple home equity loans.
How to Pay Off a Home Equity Loan
There are three ways to pay off your home equity loan:
- Lump sum: If you have saved the remainder of your loan amount in a separate account then you can pay off the home equity loan in one payment. You need to call off your lenders to ask for the final payoff amount.
- Additional principal payments: On every payment you can add a certain amount so that the principal amount can be reduced that is earning interest.
- Sporadic payments: When you have extra cash on your hand, you can add it to your loan repayments. This is a great way to use bonuses or tax refunds.
How to Refinance a Home Equity Loan:
Refinancing any type of loan means that you are going to apply for a new loan and are willing to follow its proceeds to pay off the previous loan. Similar to the first time, you need to qualify for the refinancing. Just having the old home equity loan will not make you eligible for the refinance.
For the first home equity loan, your home act as collateral to secure the loan. Most lenders require you to own a combined loan-to-value ratio of no more than 85%. That means the sum of all your outstanding home-backed debts that is primary mortgage, and home equity loan makes up no more than 85 % of the current value of your home.
In other words, you own at least 15% of the value of your home free and clear. So, you have already met this benchmark qualifying for the first home equity loan, you will have to revisit it for refinancing.
Now, your home’s value may drop as you already have taken a home equity loan. To refinance your home equity loan you must meet personal financial and credit requirements. That means you must own a very fair credit score that is starting at 580.
Although many lenders ask for 620 minimum for refinances. And of course the higher the credit score, the lower rate of interest will be offered to the borrower. You will have sufficient income to make repayments of the refinance.
Finally, you must have a good repayment record with the present home equity loan. Especially if you want to refinance with the same lender then they may hesitate to refinance you if you have late payment, missed payment, or fallen short.
If your finances are too weak but your repayments record is good with the current home equity loan then they can cut you some slack, and consider you as a reliable borrower as their loan is concerned.
The Pros and Cons of Home Equity Loans
Pros of a home equity loan:
- A fixed interest rate at a set monthly repayments for a fixed period of time.
- Lower interest rate compared to any other common forms of debts
- Easy to get a large sum of money that you may not attain through other avenues/
Cons of home equity loan:
- A lump sum amount refers to you may take out a larger amount than you require, spending the excess money meaninglessly and eroding your home’s value in this process.
- You may take on more debt payments than you can keep up with in the future.
- You can’t afford to move or sell your home if the value of your home decreases.
Can a home equity loan be in the first position?
Ans: You can qualify for a home equity loan or HELOC at your first attempt in two ways- you have paid off your mortgage and own your home outright with no such outstanding home loan debt, or you use a portion of your home equity loan to pay off your mortgage in full.
What is the minimum payment of your home equity loan?
Ans: The minimum monthly payment will be calculated as 100% of the interest owed for that period.
What are the best ways to use a home equity loan?
Ans: Some of the best ways to use a home equity loan are-
- Home improvements
- Debt consolidation
- Emergency expenses
- Business expenses
- Continuing education costs
Equity is the difference between the sellable value of the asset and the borrowing amount against it. As the value of your home increases over the long term, and you pay down the principal on the mortgage, the equity stake grows.
For some people, homeownership is the cornerstone of personal wealth. As they can use the equity for many potential purposes. Here, in this article, we have briefly discussed various aspects of home equity loans in the UK.
Hope, this guide will help you in every corner of aspects to get understand the second mortgage loan. As a beginner, you must implement a solid plan for improving your overall financial situation with a home equity loan.