Outdated finishes, flooring or carpet that has seen better days, a bathroom and kitchen that are original to the home, built decades ago. Does this sound like your home? If you own your home and don’t have the cash to update it, a home equity loan for home improvement may be the solution for you. Read on for information on home equity, how home equity loans work, and when you do and don’t want to use them.
What Is Home Equity?
When you buy a home, you are essentially investing long-term. While your home is an asset, your money is tied up and not liquid. This can change, however, as your home increases in value and as you pay off more of your mortgage.
As the percentage of what you own “free and clear” versus what the bank or mortgage holder owns increases, you build equity. Home equity is, quite simply, the difference between the market value of your home and what you owe.
For example, if the current market value (and this is important because it’s not the market value when you bought your home, but the market value on the day you are calculating your equity) of your home is $250,000 and you owe $200,000, you have $50,000 in equity.
How Long Does It Take To Build Equity?
Building home equity takes time. You can speed it up by paying extra on the principal amount of your loan. You can specify that any payments above and beyond your normal monthly mortgage payment go directly to the principal.
Your home also may increase in value, giving you equity quicker than if you are simply paying down the principal. Increasing home values are not a guarantee, so don’t count on that. The 2008 housing crisis is a good example of how home prices can drop substantially, eliminating home equity for people in many areas of the country. The longer you stay in your home, the more equity you have as well.
Taking out a mortgage on a home can be seen as a sort of forced savings account. If you continue to pay on the mortgage over time, reducing your principal, and building equity, you may eventually pay off the home or become “equity rich” which means that the amount you owe on the home is less than 50% of what it is worth.
What Is A Home Equity Loan?
You don’t need to sell your home to tap into the “forced savings account” it has created. Instead, you can borrow money against your home’s value with a home equity loan, sometimes called a “second mortgage”. The home equity loan provides you with a lump sum of money to use for things such home improvements.
An important consideration is that banks usually won’t lend you 100% of the combined loan-to-value ratio. Instead, they usually will give you up to 90% of the home’s value. Using our example above, even though you have $50,000 in equity, a bank is probably not going to give you that much for a home equity loan.
The terms and rates for home equity loans vary, so you’ll want to shop around for the best rates. The terms will depend on your credit history, how much equity you have, etc. Interest rates for home equity loans are often variable, meaning they will change based on the market interest rate.
The rate is generally lower with variable rates, but you also take the risk of that rate skyrocketing if the housing market collapses or the market interest rate is increased. A fixed rate loan may be the better you option for you, as it gives you fixed monthly payments that don’t change, no pre-payment penalties, and potential tax benefits.
When To Use A Home Equity Loan…And When To Not
When deciding on what type of loan for home improvement is best for your situation, you should consider all financing options. If you want to get a home equity loan for home improvements, you need to consider what you want to improve. Think about the loan as an investment into your house. You want to make a wise investment, of course!
Wise investments include improvements that will increase the resale value of your home, such as a kitchen remodel. There is a high return on investment for these types of improvements.
Another type of wise investment is emergency repairs, such as a new roof, new heating or cooling system, or mold or water damage. These repairs aren’t necessarily going to have a high return on investment, but they are necessary improvements in order to live in the home (and, it’s unlikely you’d be able to sell without making these improvements anyway). If you are going to get a loan for home improvement, you should focus on those improvements that are going to increase the value of your home.
How Do I Get A Loan for Home Improvement?
Now that you have decided that a home equity loan might be the right loan for home improvement to your home, it’s time to start shopping around for lenders. They will check your credit and your rates will be based on your credit score, so the better your credit, the better your loan terms.
Be prepared that you will have to provide income documentation, just as you did when you got your first mortgage, and you’ll have to pay closing costs. You’ll also need an appraisal, which you will be responsible for paying for. This will help the bank assess what the current market value of your home so they can determine how much equity you have in your home. The process can take several weeks, and you may be asked to provide more information, but patience is key. Once you are approved and the loan is funded, you can get going with your improvements with the cash to pay for them!
Spencer is here to help you. If you think the home equity loan is the way to go to fund your home improvement project, get in touch with us today to learn all about our great home equity products and rates. You can even get the process started online right now! Visit our website, contact your local financial center or call us at 1-800-363-8115.