|By Stewart Pelto on January 28, 2010
Imagine you need to pay for something big, like your kid’s college tuition, unexpected hospital bills, a home remodeling project, or even a well-deserved vacation. You know you need to take out a loan, but don’t know what to offer the lender as collateral. With a home equity loan, you can offer the value of your house beyond the mortgage balance to get the money you need.
To put it differently, most lenders will begin with 75 to 80% of your current home value and then subtract the balance still owed on your mortgage. Consider this example: you bought your home ten years ago and it is now worth $250,000. You have good credit history and expect the banks to begin with 80% of your home value, or $200,000. You still owe $100,000 on your current mortgage balance. Using these numbers, you can expect to qualify for a $100,000 home equity loan.
Note that this beginning percentage of 75 to 80% is an industry-wide average that varies significantly with both your bank and your credit score. Aggressive lenders can use your good credit score to justify pushing that number all the way up to 125%, while conservative lenders can use your poor credit score to drop that number to only 10 to 20%. To truly know how much you can borrow, you should inquire at several banks.
As you drive to the banks, you need to ask yourself this question: “Will a home equity loan work for me?” The most obvious advantage of a home equity loan is the interest rates that credit cards just can’t beat. In addition, the loan’s interest can usually be written off on your taxes. However, there are some disadvantages to consider. Although the interest rates on your “second mortgage” are attractive, they’re usually higher than your first mortgage. Banks also want you to pay back your home equity loan promptly, so don’t expect to spread out the burden over a thirty year period.
Overall, a home equity loan can be a very consumer-friendly way to provide for your child’s tuition, care for your parents’ treatments, or add space and value to your home.