My partner and I bought a home for $122k around a year ago from his family, it appraised at $190k during the inspection and loan process. It is an older home and we’d like to do renovations and eventually sell it.
We don’t have money for renovations currently, but know that Home Equity Loans exist but nothing else.
How does it work?
In: Economics
First question, how much equity do you have in your home? If only purchased a year ago, may not be much….
You go to your mortgage company. Tell them you’d like to get some of the equity from your home. They accept (let’s say $20,000). Now you owe $140k on your home instead of $120k
Everyone has been halfway right so far.
The equity is the difference between what you owe in the house and what the home is worth on the open market/appraisal.
A bank will offer to provide you with a loan for typically 70-80% of that value difference. So if you have 10k equity, you could only get a loan for 7-8k. This amount varies by bank. The lender then takes second lien position on your home, and in the event you ever sell, or have to claim a full loss on the property they will collect whatever money is left over after the primary lien holder is paid off, up until the debt is fully satisfied.
You don’t want to leverage too much of that equity for various reasons, including limiting your future profits from any sale as well as limiting your liability in the unlikely event your home value decreased.
You also could take what’s called a home equity line of credit or HELOC. This is basically the same as a loan, only the credit is open like a credit card. Use only what you need when you need it and pay back what you used like you would a credit card.
It should be noted that neither a HELOC or loan have to be with the same bank that you have your original mortgage with.
You can also do a cash out refinance, but unless you get a lower interest rate, it’s not very advantageous to do after such a short time owning the home. For starters, you have to pay closing costs as if you were buying the house all over again.
Let’s start with the concept of home equity. Your house has a market value, which is what somebody would pay for it today. This is usually an estimate based on the size of your home, general condition, age of the house, and what other similar homes nearby have sold for. Your equity in the home is the market value of the house, minus any loans you have taken out with the house as collateral (like a mortgage). So if your house is worth $190k and you took out a mortgage for $122k, you have $68k of equity in the house.
There are a couple of types of home loans. There is a first mortgage, which is typically used to buy a house in the first place. Sometimes this is called a purchase loan, because you are using it to purchase the house.
There are refinancing mortgages, where you are getting a completely new mortgage on the same house. Typically, you are doing it to either a) get better terms on your loan like a lower interest rate or longer repayment, or b) a “cash out” refinancing, where you are taking out a larger loan, repaying the old one, and using the leftover cash for…whatever. The important thing about a refinancing mortgage is that your old mortgage will go away completely, since you are using the new mortgage to pay it off.
A home equity loan is a mortgage that sits on top of your current first mortgage as a completely separate loan. It lets you use the remaining equity in your house to borrow more money, usually up to 80% of the home’s value combined. It then repays according to the terms of the loan.
Some people get home equity loans, which are for a fixed amount. Some people get home equity lines of credit, which gives you *access* to money that you can withdraw when you need it. Usually you are able to take money out on the line of credit for up to 10 years while repaying only interest, and then the balance turns into a 20 year loan.
So if you have a $122k mortgage on a $190k valued house, you currently have mortgaged 68% of the value. That means you could take out another ~$23k of loans on top of your current mortgage and still get approved (assuming everything else qualifies).
The bank can default you (ie, call the balance due) on that loan at any time for any reason, or no reason at all
Go into one eyes wide open
If you own an asset worth $190k, you can take out a loan with the asset as collateral. Banks generally want no more than 80% of the value of the asset to be leveraged, so up to $152k could be borrowed against. If you purchased the house at $122k and took out a mortgage for 80%, that would mean you borrowed $97.6k and put up $24.4k plus transaction costs to close the deal.
In this case because the value is higher than when purchased, the loan against the property is now only worth 51% of the value, and you have about 49%, or $92.4k of equity that you can borrow against. Now it’s worth noting that banks are fairly conservative. As we noted before, you can only borrow against about $50k of that. The bank wants you to have a cushion so that you take the loss and not them if the value ends up being less than appraised, or the market has a downturn. Also, they really just want you to pay them, they don’t want your house. So if you can’t prove that you can comfortably pay the new loan plus your existing mortgage on your salary, they won’t lend to you, regardless of equity. Ditto if your credit is sub-par. Lenders will be more stingy on home equity lines of credit than they will be for primary mortgages.
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