Home Equity Loan and Home Equity Line of Credit
A second mortgage is a loan that can be taken out in addition to the first mortgage loan that already exists. This is called subordinate financing. Because the subordinate financing is in a second lien position, these products often carry a higher interest rate than first mortgage products.
Home Equity Terms
Second mortgage products come in a variety of different terms. The most common being 15 to 30 years. Some second mortgage products have fixed amortization schedules and some offer the ability to pay an interest only payment. These loans with a payment that does not include any principal reduction are referred to as Home Equity Lines of Credit or HELOC.
How Home Equity Interest Rates Work
Home Equity Lines of Credit typically have a variable interest rate and can fluctuate based on market conditions. A common rate that many lenders use for Home Equity products is the Prime Rate. The Prime rate is calculated from the Federal Funds Rate, the rate at which banks borrow money. The Prime Rate published by the Wall Street Journal is a reflection of the base rate of the top 10 banks in the United States. Currently the Prime rate sits at 3.25 percent and has been stable for the past five years when the rate was set in December 2008.
Typically the rate a HELOC will have a fixed margin added to the Prime index to determine the rate at which the borrower will be charged for the loan. For instance, Prime + 1 is a common interest rate for lenders to charge. Here is an example of a payment calculation for a HELOC:
X 4.25% (3.25% + 1)
$2,125 divided by 12 months = $177.08 per month
Fixed rate second mortgage products usually have higher interest rates and shorter terms than HELOCS. This results in higher monthly payments for second mortgage products.
Home Equity Loan Eligibility
To determine the eligible borrowing power for a second mortgage or HELOC, lenders use the appraised value of the property. It is common for loans to be no more than 90 percent loan to value of the home. So, the combined first and second mortgage cannot exceed 90 percent if the value of the home. For example, if a house is worth $100,000 and there is a fist mortgage lien of $80,000, the maximum amount of the second mortgage is $10,000. Usually rates offered are lower at lower loan to values.
Second mortgage approvals generally have higher criteria with lenders wanting borrowers to have better credit scores and lower debt to income ratios. Home Equity Loans we conceptualized to offer homeowners the ability to finance improvements that they planned to make to the home. However, borrowers are not required to strictly put the equity back in their home. Second mortgages are used for many different purposes, to consolidate debt, pay college tuition, or to buy a boat or an RV.
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