The Ins & Outs of Equity and Lines of Credit

One of the biggest rewards of homeownership is the ability to build up equity. Equity can be tapped by obtaining home equity loans or lines of credit. These are low-cost funds relative to other sources of credit and are great refinancing tools.

Loans to access equity in a property are different than a mortgage to purchase a property. The traditional home mortgage sits in first position as a lien. The lender holding the first loan has first recourse in the event of nonpayment.?

When the property sells, proceeds will first go to paying the loan in primary position. Any remaining funds will be applied to a second lien.

Home equity loans and lines of credit will take second position behind the original purchase mortgage. Second-position loans present more risk to the lender for payment by the borrower and for full payoff in the event of default. The higher risk means a higher interest rate on the second loan than the first.

The home equity loan is similar to the first loan because it will also have a beginning and ending date and will be paid off at the end of the term. Monthly payments are fixed for the duration of the loan.?

A home equity loan can be a useful tool to optimize the interest rate and loan fees when a buyer has only 10% to put down. For example, if a buyer is purchasing a $100,000 home with a 10% or $10,000 down payment, the buyer will have to pay a higher interest rate for the loan and pay for mortgage insurance because the equity position would be less than 20%.?

To avoid these extra loan costs, a 10% home equity loan could be piggybacked on top of a first loan, which would now be $80,000.?

The final structure of the purchase would be an 80/10/10 loan–a $10,000 down payment, a $10,000 home equity loan and an $80,000 first loan. Since the lender of the primary loan now has less risk at 80%, the interest rate will be more competitive, and mortgage insurance is not required.?

The primary difference between the home equity loan and the line of credit is that the line of credit yields access to equity, much like a credit card. The balance of the loan and the interest rate can change monthly. Interest rates on the line of credit are tied to an economic index that fluctuates.?

The borrower can access the entire loan amount at one time or use the available funds in smaller amounts. As the loan is paid down, the line of credit becomes a revolving source of funds.

The home equity line of credit (HELOC) does not charge interest until funds are used, making these loans a nice source of emergency funds. Another pro of the HELOC is that loan costs are typically less than the fees for a home equity loan.

Having a good understanding of HELOCs and home equity loans helps you open more doors for your buyers.?

Call 800.773.6531 or email [email protected], and GenNEXT Funding can?further explain these great lending tools to help grow your business.