A home equity loan is typically based and issued on the amount of equity a homeowner has available in their property. They will generally be offered at a fixed rate and at a term of 5 to 30 years, although many borrowers choose to have a home equity loan run in line with their first mortgage. A home equity loan is often referred to as a second mortgage, and can be used for just about any purpose. The most popular use of a home equity loan is usually to complete renovation or repair work on a property, to fund an expensive purchase or to consolidate a number of debts.
Lenders who provide home equity loans will usually only lend money up to a certain percentage of a property’s appraised value. This is referred to as loan to value (LTV), and in most cases will be restricted up to a maximum of 85%. Therefore, if someone has a property that is worth $200,000, and they have a first mortgage of $100,000, they will generally only be able to borrow another $70,000 in the form of a home equity loan, as this will take their total loans up to 85% LTV.
However, in recent years the credit crunch and global economic crisis has seen the value of many properties decline significantly. In fact, many struggling homeowners have found that the value of their borrowings is far greater than the value of their property. With that said, there are numerous lenders who realize the potential in lending money greater than a property value. This, in turn, has seen home equity loans offered up to 125% LTV.
A high LTV home equity loan, however, would generally be considered as anything above 85% of the property’s value. This type of lending is generally regarded as extremely risky for both the lender and borrower. If for any reason a borrower decides that they need to sell their home, once they have paid out all their real estate fees they may be left with a significant debt that still needs to be repaid, but unfortunately they may have no further funds to repay the money. This obviously presents a huge risk to a lender, as they will still be owed money by their borrower, but may be unaware of how the borrower will repay the money.
Home equity loans are considered an extremely effective way to borrow money, as they generally offer a far lower interest rate than unsecured forms of borrowing, such as credit cards and personal loans. They also have the added benefit of being tax deductible up to $100,000, although a borrower should always remember that their home is being used as collateral, and therefore failure to repay the loan may result in them losing their home.
There are various reasons why a lender may choose to offer a high LTV home equity loan, and possibly the most obvious will be that a borrower is looking to finance a renovation that will add value to their home. This may involve spending money on a new kitchen or a second bathroom that will increase a homeowner’s property value by a significant amount.
A lender may also decide to allow a borrower a high LTV home equity loan in order to shift fairly substantial balances from their credit cards. As credit cards are likely to be charging annual interest rates that are far higher than the home equity loan, a borrower may find that they have more disposable income on an annual basis by making the switch. This, of course, will slash their borrowing costs and effectively allow them to potentially repay their debts at a quicker rate.
As mentioned, a home equity loan will have a fixed interest rate, and therefore the borrower will be able to budget their monthly payments accordingly. The loan will be received in a lump sum, and interest will be charged from the day that the loan is disbursed. Home equity loans will typically need to be repaid on a principal and interest basis, although a borrower may choose to take the interest only payment option. If this option is chosen a borrower will need to repay the loan in full at the end of the repayment schedule.
It is important to realize that not all lenders will be willing to offer high TV home equity loans due to the risk involved. It is also unlikely that a borrower will be approved for this type of loan if they have a less than stellar credit history. In fact, a borrower will need to have a very good to excellent credit score, a proven history of repaying loans on time and in full, and a secure employment history.
There are certain considerations a borrower should make prior to obtaining a high LTV home equity loan. Possibly the most important of these is if and when they are planning to sell their home. As mentioned, if you have a first mortgage and home equity loan that is greater than the value of your property, and you choose to sell your home, you will need to ensure that you have enough cash available to satisfy your lender’s requirements.
Another consideration will be the interest rate that is offered on a high LTV home equity loan. Home equity loan interest rates are typically far lower than most consumer and unsecured lending, but the interest rate is likely to rise as the potential risk of default increases. Therefore, if a borrower is looking to obtain a high LTV home equity loan they should not expect to receive the interest rates that have been advertised for a conventional loan.