Home Equity Mortgages

Home Equity Mortgages 101

The loan you take out to purchase a home is called a home mortgage. Equity is the difference between how much you still owe on your home and how much it is worth. Home equity mortgages, frequently referred to as second mortgages, allow you to turn that equity into cash. They offer a one time, lump sum payment that you can use to consolidate debt, improve your home, or cover some other important expense. The second mortgage will be repaid over a number of years determined by you and your lender. This is referred to as amortization, and could be as little as five years or as many as thirty. You will be using your home as collateral to guarantee repayment of your loan.

To figure out how much equity you have in your home, take the amount of your original mortgage, subtract the total amount you have paid on it so far, and that number is the amount of equity you have built up in your home. If you purchased a home worth $125,000, and you put a $50,000 down payment on it, your home equity would be $50,000 to begin. If you pay a total of $7,000 more over the next few years, then your equity rises to $57,000. As you continue to repay your loan, your equity should continue to grow higher, as high as 125% of the value of your home.

However, your equity can also be affected by the value of your home. If your home goes up in value, you will wind up with greater equity as long as you keep making timely payments. If your home depreciates, it lessens the amount of your equity, no matter how much you've repaid on the loan.

Applying for a Home Equity Loan

There are things your lender needs to know when you apply for a second mortgage.

Your Income

Your potential lender will need to verify the amount of your income, so be prepared to show your most recent W-2 form and current pay stubs.

Your Credit History

Lenders need to know if you are a good debt risk, and will need to see a copy of your current credit report from one or more of the three main credit tracking companies: Experian, Equifax, or TransUnion. If your current debt ratio is larger than the value of your home, you will likely have trouble being approved. If your credit record is good and your rate of debt is low, you've just cleared a major hurdle.

Loan vs. Value of Your Home

The lender will also take the actual worth of your home into consideration, adding the amount still owed on your first mortgage to the amount of your prospective home equity loan. Since your home will be the collateral to guarantee repayment of your loan, the total of both mortgages needs to amount to no more than the current value of your house. This way, both your original mortgage holder and your home equity lender can recoup their losses by selling your home if you default on your loans.

Price of Home Equity Mortgages

The original amount of the home equity mortgage isn't the only thing you'll be paying. There are other costs incurred when borrowing against your home equity.

Fees and Closing Costs

Expect to pay fees for:

• Your loan application and any documents that are prepared for your mortgage.
• A property appraisal to show the current worth of your home.
• A title search to make sure there are no outstanding liens on your property.
• An attorney to look over the paperwork and make sure everything is in order. Your attorney or title agent should be looking to protect your interests.

Interest

Don't think you're through once you've paid the up front fees for your home equity mortgage. In addition to the principal, the original amount being borrowed, you'll be paying a little extra each month in the form of interest. Interest comes in two basic forms:

• A fixed interest rate results in a steady payment amount throughout the duration of the loan.
• An adjustable interest rate can raise or lower your monthly payments depending on current percentage.

Tip: Find out if you can handle larger payments by computing those higher interest rates with an mortgage calculator.

It's Your Decision

Should you go ahead and apply for a second mortgage? Ask yourself these questions:

• Do I have enough income to cover the monthly payments?
• Will a one time, lump some loan work the best for my needs? One alternative is a home equity line of credit, an open line of credit against your equity, giving you flexibility with when and how much you borrow.
• Is what I'm borrowing the money for truly needed?
• If using the loan to consolidate debts, do I have the will power to resist running up credit cards and accruing more debt? Once you use up your home equity, it's gone unless you repay the debt.
• Am I planning on selling my home in the near future? Home equity mortgages must be paid off at the time of sale, and usually charge a prepayment penalty for paying the loan off early.
• Will there be a balloon payment at the end of the mortgage? Some loans include interest and principal in each monthly payment, so when you reach the end of the loan term, you're finished. Other types of home equity mortgages may charge for the interest from the beginning of the loan, and then bundle the remaining principal into one last balloon payment at the term's end. Then you may have to make a choice between refinancing the remainder of the debt or losing your home. Avoid mortgages with balloon payments if at all possible.

These are all important questions, because the collateral for your loan is your home, and you can lose it if you fail to repay that second mortgage.

Conclusion

Home equity mortgages should never be entered into lightly because you are putting your home at risk. However, if you are good at managing your money, they can provide a way to access your home equity and turn it into cash when you need it the most.

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