How many types of home equity loans are there?
Let us explore different types of home equity loans.
Fixed-rate home equity loans
Fixed-rate loans are comparatively simple. The financial institute or lender provides a lump-sum amount to the potential borrower. This sum must be paid with a settled interest rate over an agreed period. Moreover, monthly payments and interest rates are invariable over the loan duration in this type of loan.
Fixed-rate loans function from 5 to 15 years. Furthermore, the closing cost of this loan is often equivalent to home mortgages.
Should I apply for this loan?
This loan is best for borrowers who require one-time cash. For instance, if you need $40,000 for home maintenance and a $5,000 medical bill. In this case, a total of $45,000 will be lent to you that you would need to pay back with an interest rate.
Home equity line of credit
This type of loan is explained as a form of revolving credit. During this loan, the monthly payments are influenced by variable interest rates and can be borrowed from time to time. The eligibility criteria are based on a particular credit score. You can take out only a specific credit limit on a revolving basis for up to 10 years, also described as a draw period.
Furthermore, if the draw period of 10 years expires, you will enter a repayment period where amortized monthly payments and interest rates are mandated.
Also, the monthly payments will substantially increase when calculated with interest and principal if you had opted for interest-only payments in the draw period.
Cash-out refinance is clearing off an existing mortgage loan with a new loan. This loan is taken out conventionally due to refinancing a mortgage with lower interest or customizable loan terms. This way, the borrower may be able to conserve some money in the future. However, if you increase the loan duration, you may not do so.
In addition, with home equity loans, cash-out refinance usually comes with some costs associated. Plus, it will have higher closing costs than home equity loans.
This loan is suitable for residents who plump for an integrated loan and favor securing a lower interest rate or distinct loan duration. Likewise, homeowners who purchased their home ten years back with a 6% mortgage interest can now benefit from a home equity loan and may have relatively better credit this time. In addition, the homeowner can refinance their mortgage with a 4% interest rate while cashing out.
A traditional home equity loan is a fixed-term loan lengthened for a stated duration combined with an interest rate, and principal added monthly installments.
They are quoted as first mortgages before home equity loans. A lender advances money to the debtor using their property as collateral in each case. Moreover, both loan types mandate the assessment of borrowers’ financial position and credit score to figure out loan rate, additional fees, and loan length.
Financial risks with home equity loans
Two potential financial setbacks are here if you fail to clear off home equity loans.
- Be mindful of paying your monthly installments timely if you do not, you may lose ownership of yourself. This is an alarming consequence since you acquired this loan against your home. You must set aside the settled amount or automate it to avoid unpleasant outcomes.
- Do not overlook the significance of planning a budget to attain financial security. It is imperative to arrange for monthly payments of home equity loans beforehand to avert payment surprises and the perils of defaulting on your loan during the repayment term. In addition, consumers who do not leave room for an increase in their repayments with the inclusion of principal and interest rates experience substantial financial drawbacks.
- Financial advisers suggest making interest and principal during this period to reduce the potential risk of unaffordable repayments.