Question:

Can you explain first equity and home equity loans?

Answer:

Well, yes. When becoming a homeowner, a borrower should learn first what is equity and home equity loans, and loan to value ratio (LTV).

All home mortgages are in a way home equity installment loans, as your house serves as collateral for the loan.

A standard first mortgage loan is one used to purchase a house. Second mortgages, home equity loans (HELs) and lines of credit (HELOCs) are used to access the equity lying in your home when your first mortgage balance goes down a little.

What is home equity?

Firstly, equity is what you own in your house. If you bought a house sometimes ago and had it for 10 years you have paid it off partially. For example, you bought a house worth $300,000 with $50,000 down. That is, at the time of the purchase you acquired house equity of $50,000 and took a mortgage for $250,000.

Ten years later, you have paid off another $50,000 of your loan. Now, you owe only $200,000 to the lender. What is your home equity at that time? Isn't it $100,000? It could be. It depends on how your home is appraised in comparison to similar homes in the neighborhood.

  1. If your house appraises at $280,000 you owe $200,000 to the lender so your equity is $80,000.
  2. If your home appraises at $350,000 due to significant house value appreciation in your area, your equity will be $150,000.

In simple words, your house equity is the difference between your house's current market value and your mortgage debt.

What is LTV (loan-to-value) and why is LTV important with home equity loans?

Home equity installment loans are allowed to reach from around 85% to 125% combined LTV. That is, your first mortgage balance and your 2nd mortgage/HEL/HELOC combined cannot go over your lender's CLTV.

In the above example, if the lender has a CLTV of 90% and you have a house worth $350,000 you could borrow up to 90% of $350,000, or up to $315,000. In this particular example, you owe $200,000 so you could take out some $115,000 minus loan fees.

How many ways to tap home equity?

You can:

  • refinance your first mortgage with cash-out;
  • take a standalone 2nd mortgage;
  • take a HEL or HELOC.

How do you decide which one to choose?

A HEL and HELOC can be easily taken for smaller amounts - like $10,000. Often, lenders will require that you borrow at least $30,000 for a standard second mortgage. However, $30K and $50K HELs and HELOCs are also widely available.

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