You have wanted to remodel your basement since you bought the house 10 years ago. Your family is growing, and you need to get rid of the 1970s orange shag carpeting and dark paneling. It could be a great second family room down there, but where can you get the money?
Well, a second mortgage might be your answer. It’s also called a home equity loan. You can also get a home equity line of credit (HELOC). A HELOC is revolving debt like a credit card, says Keith Gumbinger, vice president of HSH, a financial surveyor and publisher of consumer loan information.
“If you have a lot of home improvement to do, a home equity line of credit might be the best bet for you because you can borrow from it and pay interest on it as you need it,” he says.
A home equity loan is just a one-time loan that has a fixed interest rate.
More and more people are taking out home equity loans. In fact, lenders wrote up more than $60 billion in home-equity lines of credit and closed on second mortgages in 2013 — a jump of 36.4 percent from 2012, according to research done by Inside Mortgage Finance, a mortgage industry publication.
“A home equity loan is just like your first mortgage. Your house is on the line if you don’t pay it back,” says Cindy Balser, senior vice president of Key Bank, Cleveland, Ohio. She also serves as chair of the Home Equity Lending Committee for Consumer Bankers Association.
“It’s important for a customer of a home equity loan to understand that the process today is different than when they asked for a mortgage or home equity a few years ago,” she says. “You need to understand that the lender might ask you questions that they never asked you before. If you understand all the documentation that is required and have the proper expectation, you will be fine.”
Even through the mortgage home crisis, banks were still offering home equity loans. But of course, home equity loans mean that your home has to have some equity in it. During the downturn, many folks didn’t have much equity because house values were plummeting, she says.
Now, that things are getting better, home equity loans are available more readily. They can range in interest rates from 4 to 7 percent, Balser says. Plus, closing costs and fees do vary from place to place. Shopping around for the best deal can benefit you and save you some money. And just like the interest you pay on your first home mortgage, the interest on home equity loans is often tax deductible.
“The interest rate you pay on a home equity loan all depends on the term, the bank and the client. One price does not fit all, and everyone has different needs,” she adds.
People use home equity loans for big expenditures such as home improvement, college costs, a vacation and consolidation of other debt. The amount of money someone can borrow is different from bank to bank, too, plus it all depends on your loan-to-value ratio of your first and second mortgages combined.
By taking out a second mortgage you are adding to your overall debt, and it is attached to your home. If you can’t pay it back – just like your first mortgage – you could potentially lose your home.
Access and availability to home equity loans has changed recently, says Gumbinger.
“There were boom times in home equity 10 years ago. We are not back to those times yet,” he says.
However, when the value of homes dropped, lenders with first home mortgages could barely get money back from all the foreclosures.
“There was hardly anything left for those lenders who were holding the second liens (second mortgages) to a home. The lenders looked at their books. They were looking at 100 percent loss,” he says.
During this economic downturn, many people were caught in the middle of this home equity fiasco. Even though they had good credit, the bank cut them off of their equity line of credit. They were unable to borrow any more money for such things as their child going off to college or eldercare for their parent or fixing up their homes. Some banks shut off these lines of credit to even people who could pay them back, Gumbinger says.
“It made it very difficult for borrowers to access their money that they had already been approved to borrow,” he says. “But now, home prices have begun to recover. The growing economy has been growing the prospect of lender.”
Just like with other loans, home equity loans now come with stiffer underwriting standards. It’s hard right now to get a second mortgage beyond the 80 percent of equity of your home even if you have deep equity. For instance if your home has $50,000 in equity, you might be able to borrow up to $40,000 in a home equity loan.
“But the rules are there to protect the lenders and protect you,” Gumbinger says. “But more lenders are making loans again. Rising home prices is still the key. Actual appraisals are being done today for home equity loans.”
The growth in home equity loans is coming from the smaller to midsize lenders, he says.
“They will ask you these days what you are going to do with the money with a home equity loan. The scrutiny is much bigger now. If it is going for home improvement, it might be easier to get the loan,” he said. “It is the No. 1 reason people get a second mortgage.”