If you’re looking to take out a second mortgage, you’ve likely heard of a home equity loan. But what exactly is this form of financing, and who should take advantage of the resource? In this article, we’ll break down home equity loans and answer some key questions like:
- What is a home equity loan?
- How does a home equity loan work in Texas?
- What is the difference between a home equity loan and a HELOC?
- What is the difference between a home equity loan and refinancing?
- What are some of the advantages and disadvantages of obtaining a home equity loan?
Here’s your comprehensive primer for home equity loans in Texas.
What Is a Home Equity Loan?
A home equity loan is a type of second mortgage in which money is borrowed against the equity that you have in your home. Much like your purchase mortgage, your principal and interest are repaid monthly over a set number of years. There is no set purpose for the funds from a home equity loan. It can be used on the property or not— it is entirely up to the borrower.
How Does a Home Equity Loan Work in Texas?
Texas has some unique laws when it comes to equity loans. For one, the loans cannot exceed an 80% loan-to-value ratio (LTV). This means that the amount of the loan— and any other mortgage you have against the property– can’t be more than 80% of your home’s value.
For instance: you have a home that’s valued at $200,000, and you still have $120,000 remaining in payments. A little basic math shows that 80% of the home’s market value is $160,000. The difference between the maximum lendable amount and the debt is the home equity that is available to you, which in this case, is $40,000.
Texas restrictions don’t stop there. There is also a law in place that prohibits taking out more than one equity loan at a time. You must pay off your existing loan in its entirety before you can borrow against the value of your house a second time. And in addition to this, you can only take out one home equity loan or HELOC per calendar year— even if you’ve fully paid off the old one.
What Is the Difference Between a Home Equity Loan and a Home Equity Line of Credit?
A home equity loan and home equity line of credit (HELOC) have several things in common. For one, they are both borrowed against the equity that you have in the home. Both also use your home as collateral.
But they also have a few key differences.
A home equity loan is a “closed-end” loan. This means that the entire loan amount is paid out one time, upfront. This type is typically what people think of when it comes to mortgages and loans. Most home equity loans are fixed-rate loans, which means you will make a regular payment each month.
A home equity line of credit, on the other hand, is an “open-end” loan. There is a maximum limit to the loan, but instead of being paid out at once, it is disbursed on a take-it-as-you-need-it system. You aren’t required to take out the full amount that you’ve been approved for and can make payments as you use the money. Interest rates on HELOCs tend to be variable, meaning that the amount of interest you pay may change as time goes on.
What Is the Difference Between a Home Equity Loan and Refinancing?
Home equity loans and home equity lines of credit may be closely related, but home equity loans and refinancing are a bit different.
When refinancing, the borrower completely pays off their existing home mortgage with another loan. This is usually done because they find a lower interest rate or better terms. The result will be a single mortgage on your home. With a home equity loan, you come away paying off two loans— the purchase mortgage and the new loan. One does not replace the other.
What Are Some of the Advantages and Disadvantages of Obtaining a Home Equity Loan?
Of course, there are both advantages and disadvantages to the borrower. Here are a few things to keep in mind as you’re doing your research.
- Cash to do what you need: Whether you need some extra money to make home improvements or are looking to put the money elsewhere, such as debt consolidation, this is one way to take out a large sum of money.
- Relatively low-interest rate: Not only can you borrow large sums of money, but home equity loan rates in Texas are relatively low compared to other forms of borrowing, such as a credit card.
- Other costs: Costs associated with taking out another loan can add up. Luckily, lenders in Texas are required by law to be transparent about these costs, so you can see exactly what you’re getting into.
- Riskier way to get money: Home equity loans are borrowed against your house, which puts it in danger of foreclosure should you suddenly become unable to make payments. This makes it a riskier borrowing option.
Obtaining a Home Equity Loan
Obtaining a home equity loan is much like getting a purchase mortgage. You’ll still need to qualify and meet certain requirements such as a minimum credit score and proof that you can repay the loan. Even with your home as collateral, financial institutions still need to make sure you can repay your loan.
Credit unions have some of the most competitive rates in Texas, as well as a whole host of other added benefits. Also, be sure to review your financial goals with your advisor. Knowing when or when not to borrow money can make a huge difference for your financial health.
It’s ultimately up to you to decide how to spend your money from a home equity loan, and it’s always in your best interest to spend it wisely.
Originally published on Friday, November 8, 2019. Updated on Monday, July 20, 2020.