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What You Need to Know About Home Equity Loans

A home equity loan is also known as a second mortgage. This type of loan applies to people who have paid off a substantial portion of their first mortgage. As a homeowner, you may borrow against your equity in your home. If you then use the funds to extend or substantially improve the home, the interest on the loan may be tax-deductible, according to the Tax Cuts and Jobs Act of 2017.

tiny wooden homes next to a calculator

Your equity is the difference between the home’s value and how much you still owe on your mortgage. To qualify for a home equity loan, you may need to have at least 15% equity in your home. A bank will use a loan-to-value (LTV) ratio to help determine whether you qualify. If you’d like to assess your LTV, divide your current mortgage balance by your home’s value. For example, if you owe $90,000 on your mortgage and your house is valued at $175,000, you would divide 90,000 by 175,000. This equation would give you .51, or 51%, meaning you have 49% equity in your home.
As with any type of loan, the lender will also look at your current income, repayment history, credit score and debt-to-income ratio. These factors will help the lender determine their level of risk.

Two Types of Home Equity Loans

Depending on your financial needs, you can choose between two types of home equity loans: home equity lines of credit (HELOCs) or fixed-rate loans.

Home Equity Lines of Credit

A HELOC is a line of credit that allows you to access funds as you need them — perhaps through a credit card connected to the account, checks, or an online transfer of funds. You may not incur closing costs with this type of loan, but a bank may require minimum withdrawals over the draw period of the loan.
The draw period (or term) is the span of time during which you can use the funds as needed. Often, this period lasts 10 years. During the draw period, you may only have to pay the interest on the loan. Depending on your bank, after the draw period ends,  you may automatically enter the repayment period, or you may be required to refinance the HELOC to repay the principal and interest due over a new loan term. Read more about obtaining a HELOC in "How Long Does it Take to Get A HELOC?"

Fixed-Rate Loans

A fixed-rate loan is a home equity loan that provides a lump sum to the homeowner at the outset of the agreement. These loans typically offer a pre-agreed upon rate of interest, meaning you won’t be surprised by the amount you owe each month. The life of the loan can run anywhere from 5 to 15 years.

Why Get a Home Equity Loan?

There are several reasons a homeowner would take out a second mortgage. If you’re planning to remodel your home with improvements that would add value, you can leverage your current equity in the home to create more equity as the value increases. As mentioned above, the interest on a loan for qualifying home improvement projects could count as a tax deduction. Some homeowners take out home equity loans to pay off other debts with higher interest rates.
Whatever your reason for considering a home equity loan, your team at First National Bank and Trust can help. Our loan process is simple and quick, and decisions are made in-house. Call or stop by your local branch in Southern Wisconsin or Northern Illinois. Our team would be happy to answer any questions.