What is a home equity line of credit?
Home equity line of credit corresponds to the maximum amount of money that the bank agrees to lend you by taking a guarantee on a real estate you own. It takes into account the estimated amount of your property, the balance of the loans remaining to be repaid, and a ratio (mortgage ratio) of between 70% and 80% in general.
The bank will also study in parallel your debt capacity and average time remains to live before finally proposing a mortgage amount. That is, you can take advantage of the value of your property with a line of credit if these criteria fall on your favor.
How to calculate your Home equity line of credit?
Each bank may have its estimation method. However, we can retain a quasi-general formula:
Mortgage Margin = (Estimated Property x Mortgage Ratio) – Current Loan Balance on this Property.
Home equity line of credit in details
When you are purchasing a home or looking to do a mortgage refinance, one of the most common terms you will hear is “home equity.” You need a basic understanding of this term and what it means to you before you make any important decisions about mortgage refinancing or a home purchase.
When you put money down on a home, or make your down payment at closing you are actually paying for equity in your home. The difference between the appraised or market value of the home and the amount of your home loan is your home equity. The lender will usually only lend you 90% of the value, so with your down payment you will start with a 10% home equity.
Understanding the home equity is an important factor when you are looking at a mortgage refinance. If you do a streamlined refinance, you are simply rolling the loan over to a new interest rate. However, if you are getting a cash-out refinance, your home equity line of credit will be the determining factor in the amount of cash you can have.
Here is home equity example
For instance, if your home’s value is $100,000 and the current amount of your mortgage loan is $60,000, you have $40,000 in home equity. The bank will lend you up to 80% of the value of the home, so your mortgage refinancing nets you a new loan of $80,000, and you will get $20,000 out in cash to use.
If you need to get a bad credit mortgage when you refinance, you may be able to use the cash out from your home equity to pay off a high interest debt so that you can make your home payments more easily. Making your payments on time or paying additional money to the principal of the loan will help your equity to grow more quickly so that you will be able to have it there if you need to access it in the future.
Advantages of Home equity line of credit
The benefits of a line of credit are many, among them include:
Using it for home renovations;
paying for credit cards with a higher interest rate;
No limit on the amount of capital repayments and no penalties.
Disadvantages of Home equity line of credit
The ability to access funds quickly can create great financial hardship if you are not vigilant. Monitoring your expenses and maintaining the same consumption habits should be considered to avoid financial trouble in the future.
The interest rate that applies to a line of credit will fluctuate according to market conditions. It is therefore less predictable. If interest rates rise significantly, you may find it difficult to repay your loan.
Some Questions to Consider
- How will I manage my expenses with the line of credit and meet my budget?
- Does the line of credit include fees and how much do they cost?
- Can I make this purchase now using a line of credit or do I have to wait to save this money?
- How much can I repay each month?
- Do I have to have Line of Credit insurance in case of disability or death?