Home Equity Loan: FAQ

Home Equity Loans are a potentially money-saving option for homeowners who want to consolidate debt and/or turn some of their bad credit into good credit. The possible tax deductions on home equity loans make them potentially useful for debt consolidation, since other personal and consumer loans typically have no tax deductions and higher interest rates. A home equity loan can also be used for home improvement purposes, and certain tax advantages can apply.

According to current home equity statistics from the U.S. Census, approximately 7.2 million Americans obtained home equity loans in the past year. However, not all loans are right for everyone. It is important to decide which type of home loan is the perfect fit for you. To be sure that you are making a confident financial decision before you sign on the dotted line, read on for answers to frequently asked questions (FAQ) about home equity loans.

FAQ: Are Home Equity Loans (HEL) and Home Equity Lines of Credit (HELOC) the same thing?

A: No. Although both of these loans are of second mortgages, a HEL and a HELOC have some important differences. With a HEL, you receive a lump sum of money, while a HELOC works more like a line of credit.

The interest rate on these loans also works differently. Home equity loans generally have a fixed interest rate, but according to bankrate “almost always carry fees and closing costs, which many lenders do not generally charge for credit lines.” While home equity lines of credit may be free of some of these costly up-front fees, keep in mind that they are also variable rate loans, which means that the interest rate can change over time, according to the prime interest rate set by the Federal Reserve.

When choosing between these loan types, ask yourself whether receiving your loan all at once or having access to a line of credit works better for you.

FAQ: What Is a Loan-To-Value Ratio?

A: The loan-to-value-ratio is the difference between the amount of your current mortgage and the newly appraised value of your home. This ratio will be figured into the loan terms of your second mortgage.

FAQ: Is Home Refinancing a Better Option Than A HEL or HELOC?

A: That depends. If you decide to refinance your current mortgage, you may be able to obtain a lower interest rate, which means lower payments, and the possibility of a cash-out refinance.

Obtaining an interest-only refinance is also a possibility. However, while an interest-only lowers your payments, it can also lower the equity in your home and, says CFA for bankrate, Don Taylor, “only makes sense for people who don’t plan on being in the mortgage or house for a long time.”

If you are happy with the interest rate on your current mortgage, it makes more sense to consider a HEL or HELOC, especially since it is possible to refinance your first mortgage as well as your second in the future if interest rates do take a dip in your favor.

FAQ: What Is a Subordination Clause and how does it relate to a HEL?

Depending on the lender, a subordination clause or agreement most often means that before you can get a second mortgage, the first mortgage company must agree to allow the second mortgage to be placed in first lien position. The new loan then has the priority in case of a foreclosure.

This is especially important down the road if you pay off your first mortgage, because the lender in charge of your second mortgage can then write a new first mortgage and place that in first lien position, which will help protect your interest rate, since the rate for second mortgages is higher.

Terms of subordination clauses can vary by lender, so it is important to have a discussion with yours before entering into any agreement.

Being an informed consumer is the first step toward making sure you get the right loan for you. Be sure to talk to your lender and weigh your options carefully before making a final decision.