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A Guide to Home Equity Loans

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Homeowners who need to take out large loans should look no further than their own properties. Home equity loans, often referred to as second mortgages, are a realistic solution to finding the funds, as your home’s equity will be used as collateral when you borrow money. According to an October 2018 Mortgage Monitor Report by Black Knight Inc., Americans have an estimated $5.9 trillion in tappable equity from mortgage properties at their disposal.

Here’s a closer look at what these loans are, how they work and how they’re being affected by the current housing environment. Despite rising interest rates and new tax law reforms, they’re still a relatively safe way for you and your family to get the money you need.

How does a home equity loan work?

Interest rates

Just like the majority of mortgages on the market today, home equity loans usually have a fixed interest rate, which means you’ll pay the same amount in interest over the life of the loan. However, these rates tend to be higher than you would find with a traditional mortgage.

“Interest rates tend to be higher because the loan is in second position,” said Robert E. Tait, a senior loan officer with Allied Mortgage Group in Pennsylvania. “The bank is assuming a greater amount of risk because you’re more likely to pay your initial mortgage first if something happens to your income.”

As of the time this was written, the rates advertised through the LendingTree platform ranged from 4.25% to 6%, depending on how much is borrowed. LendingTree is the parent company of MagnifyMoney.

Terms

Home equity loans operate similarly to traditional mortgages where the loan term is concerned. They are paid on a fixed amortization schedule, or loan term, that’s usually 10, 15, 20 or 30 years in length.

Similarly, when you make a payment each month, you’re paying down a portion of both the principal and the interest. In this case, it’s important to continue making your payments because your home is collateral. If you stop paying, the lender can foreclose on your home.

Fees

“These days, most home equity loans are really inexpensive,” Tait said. “The lender is paying a very small processing fee, people are moving toward electronic appraisals and most of the time, there’s no need for title insurance.”

However, Tait cautioned that although an electronic appraisal is cheaper, the value of the home may come in lower. If that happens, you can always elect to have a traditional appraisal done, but you’d have to pay for it.

In addition to the upfront costs, there are also taxes to think about. In the past, homeowners were able to deduct the interest paid on home equity loans, regardless of where the money was spent. These days, though, the process is a little different. Since the passage of the 2017 tax reform law, interest from a home equity loan can only be deducted if the funds are used to buy, build or substantially improve the home that secures the loan.

Why would you take out a home equity loan?

Because home equity loans are paid out in one lump sum, they can be an appealing solution to a variety of high-cost situations, such as making home improvements, paying off medical debt or financing your child’s education.

However, even though these loans tap into the equity in your home in exchange for payment, they have the benefit of remaining separate from your mortgage. This allows you to keep the mortgage’s current terms, as well as the progress you’ve made in paying it off.

“Interest rates five or 10 years ago were lower than they are today,“ Tait said.

“A lot of the time, you’ll see people who have been in their homes for a while at those low interest rates, but they’ll want to tap the equity in their home to help pay for college. A home equity loan lets them still keep those low rates while getting the money that they need.”

As for whether that benefit has changed in the face of today’s rising interest rates, experts believe there’s still benefit to be had.

“Interest rates are less of a slam dunk than they were a few years ago,” said Kevin Leibowitz, CEO and mortgage broker at Grayton Mortgage Inc. in New York. “But they’re still fairly low from a historical prospective. You’re still paying less than you would for a personal loan of the same value.”

Qualifications for getting a home equity loan

For the most part, qualifying for a home equity loan is a lot like applying for your first mortgage. Just as if you were seeking a traditional mortgage, the lending company will look at a variety of factors, including your employment information and your credit score.

“As a rule of thumb, you need to have two years of W-2s that show stable or increasing income, a credit score of at least 620 and a debt-to-income ratio of 43% or less,” Leibowitz said.

However, for home equity loans, there’s one additional factor that has to be evaluated. Lenders also look at the amount of equity that you have in your home because it helps them decide the amount they’ll let you borrow.

For reference, your home equity can be calculated by taking the appraised value of your home and subtracting the balance on your current mortgages.

Before you start thinking about how much money you have at your disposal, however, know that lenders don’t let you borrow against the full amount of equity you have in your home. The amount you can borrow is typically limited to 85% of your equity.

Additional costs of home equity loans

Though home equity loans may be getting less expensive, keep in mind that the exact fees that you’ll be charged will vary by lender. Some may waive fees as part of their offerings, while others will not.

In general, you should be prepared to pay between 2% to 5% of the loan’s value in closing costs. Below is an explanation of what these costs cover.

Application fee

Some lenders may charge a fee for the initial tasks required to approve your loan, such as running a credit check. These fees, ranging from $25 to $150, may be used simply to ensure that the borrower doesn’t go away.

Home appraisal

As mentioned earlier, in order to find out how much equity you have in your home, the lender must first find out your home’s fair market value. This is done by ordering an appraisal, which can cost between $300 to $400. Sometimes, automated or “drive-by” versions are used, rather than the traditional in-person method.

Document preparation

Some lenders charge a fee to prepare all the documents related to closing. Usually, a lawyer or other financial specialist will complete this task.

Title search

A title search is used to discover the rightful owner of the property so that when you take possession, you can rest assured that you own the property outright. It’ll cost around $75 to $100.

Tips on finding the best loan for you

“Your first call should be to whoever holds your first mortgage to see if there’s a program available to you,” Leibowitz said. “The approval process will likely be easier, and you may get better terms than you would see with some of the larger lending institutions.”

However, regardless of where you do your shopping, do your own research, including gaining an understanding of all loan documents.

“Research the terms of the loan in full — not just the interest rates — before you sign anything, Tait advised. “A lot of times, I see people who are obsessed with getting the lowest interest rate and cheapest fees.”

“I like to say an eighth of a point won’t change your lifestyle, but what could is accidently getting into the wrong product. Make sure you understand exactly what you’re agreeing to before signing on the dotted line.”

Finally, be sure to look into the lender, as well.

“Bottom line,” Tait said, “engage with a person who you trust, who’s been referred to you. Do your research. Talk to them. Get comfortable with who you’re going to use.”

Is a home equity loan right for you?

Taking out a home equity loan is a big decision, but if you’ve cared for your home and worked hard to pay it off, the equity you’ve built may just be one of your most valuable assets. In addition, this type of loan’s fixed interest rate and repayment schedule make it an attractive choice for those who need a lump-sum payment to take care of expenses.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Tara Mastroeni
Tara Mastroeni |

Tara Mastroeni is a writer at MagnifyMoney. You can email Tara here

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A Guide to Cash-Out Refinancing

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Sometimes you need a little extra money to help with life’s big expenses, such as college tuition, home improvements or medical debt. A cash-out refinance on your mortgage allows you to leverage the equity in your home to get the cash you need. Keep reading to learn more about what cash-out refinancing is, how it works and how to make this process work for you.

How a cash-out refinance works

Normally, when you refinance your mortgage, you take out a new loan on your home with the intent of using it to pay off your existing loan. Doing so allows you to secure a better interest rate, adjust the length of your mortgage or consolidate debt if you have multiple liens on the property.

A cash-out refinance works in much the same way, except you take out a loan for more than the amount you owe on your mortgage. In this case, you use some of the equity you have built up in your home to get a cash advance. You can then use that cash to pay for your expenses and pay back the larger mortgage over time.

For example, let’s say you owe $100,000 on your $200,000 mortgage. With a cash-out refinance, you could potentially take out a new mortgage worth $150,000 — $100,000 would go toward paying off your old loan, and you’d have $50,000 for other expenses.

What are the requirements?

You’ll need to show documents when you apply for a cash-out refinance. The documents are similar to those you provided for your mortgage application, according to Adam Smith, president of the Colorado Real Estate Finance Group in Greenwood Village, Colo. They may include a W2, tax return, pay stubs, bank statements and statements from any assets or debts.

However, some requirements will be different from the first time around. In addition to documentation, a lender will look at the following for a cash-out refinance.

Credit score

The necessary credit score for a cash-out refinance loan is a bit higher than it is for a traditional mortgage. While lenders typically look for a credit score of 620 for a conventional mortgage, a score of 660 or above is required for a cash-out refinance.

Debt-to-income ratio

Your debt-to-income ratio (DTI) is the measure of your total monthly recurring debt divided by your total monthly income. Lenders look at this before approving you for a loan because it’s an indicator of how easily you’ll be able to manage repayment. In this case, you want your ratio to be less than or equal to 36%.

Loan-to-value ratio

Your loan-to-value ratio (LTV) is the comparison of your loan amount to the appraised value of your home.

“After the recession, most lenders started putting caps on the percentage of loan-to-value that you could borrow on a cash-out refinance,” Smith said. “Making sure that you still have some equity in your home protects you from owing too much and makes the investment safer for you and the lender.”

For the most part, your LTV cannot exceed 80% if you want to qualify for a cash-out refinance. However, this guideline may be specific to your loan program. FHA loans, for example, have an LTV limit of 85%, while loans backed by the VA have no LTV requirement.

What purposes can a cash-out refinance serve?

With a cash-out refinance, Smith said, “you can do essentially whatever you want. “The equity in your home is a savings account — that’s yours.” You can use it to pay off other debts, pay for your child’s college or make home improvements, for example.

However, Smith cautioned that states may have different rules and regulations for how the money from a cash-out refinance can be used. “In Colorado and some other states, you have to justify why this money is so important to you that you need to refinance,” he said. Smith recommended checking with your loan officer to see if any limitations apply to you.

Standard vs. limited cash-out refinance

Typically, the money that you receive from a cash-out refinance can be used for just about any purchase. This is what’s known as a standard cash-out refinance. However, some loan programs (like the VA’s cash-out option) put limits on what the funds can be used toward. As the name suggests, this is what’s known as a limited cash-out refinance.

According to the Fannie Mae guidelines, limited cash-out refinancing can be used for the following:

  • Modifying the terms and interest rate on an existing mortgage
  • Paying off the balance of an existing mortgage (including prepayment penalties)
  • Paying off construction costs to build a home
  • Paying for closing costs
  • Buying out a co-owner
  • Paying off a subordinate mortgage lien
  • Paying off the balance on Property Assessed Clean Energy (PACE) loans or other debts used for energy-efficient improvements.

You can also get a small amount of cash back from a limited cash-out refinance loan, but it cannot exceed 2% of the new loan value nor $2,000, whichever is more.

Risks of a cash-out refinance

Home improvements are considered a good use of a cash-out refinance because they increase the value of the home. Paying off high-interest debt could be another smart use of a cash-out refinance.

However, doing a cash-out refinance for more frivolous purchases is risky. “If you go back 10 to 15 years ago, people were treating their homes like cash registers and taking money out to go on vacation and buy jet skis,” said Jim Sahnger, a loan officer with C2 Financial Corporation in Florida. The danger is that you borrow for luxury goods or “wants” versus “needs,” and end up with debt you can’t pay off.

Smith advised thinking about how your monthly payment will change after a cash-out refinance.
“There’s a good chance that your payment may be much higher than it was before,” he said. ”Before you take the money out, be sure that you’re able to make sense of what this change will look like in your current budget.”

Smith also warned that there’s a small chance you could end up underwater on your loan.
“There have been a lot of stops put in place since the last recession to make sure that doesn’t happen,” he said. “However, if the value of your home drops dramatically, you could end up having borrowed more than your house is worth.”

Alternatives to a cash-out refinance

If you’ve read the above and don’t think cash-out refinancing is the right fit for you, you may want to consider some of the following loan options:

Home equity loan (HEL)

Often, a home equity loan is referred to as a second mortgage because, like most first mortgages, this type of loan disburses the money to you in a lump sum and comes with a fixed interest rate. It uses the equity in your home as collateral, which is paid back over time, using fixed monthly payments.

Home equity line of credit (HELOC)

A home equity line of credit functions more like a credit card. Initially after taking out the loan, you enter what’s known as the “draw period.” During that time, typically 10 years, you’re given either checks or a credit card to draw upon the equity of your home as you wish. As with a credit card, you can borrow, pay back and borrow again against the line of credit.

You only have to worry about paying back interest during the draw period. After it ends, you then have to start paying back the loan principal at an adjustable interest rate.

Personal loan

Personal loans are different from HELs and HELOCS in that they are unsecured, meaning that they don’t use anything as collateral. This makes them much more of a risk for the lender, which is why they often come with stricter qualifying requirements and higher interest rates.

Cash-out government loan options

If you’re thinking of doing a cash-out refinance, there are government-backed options at your disposal. These loans are insured by federal agencies, which makes them less of a risk for the lender. As a result, they often have more lenient qualifying requirements and better terms than your standard cash-out refinance. Here are your options:

Federal Housing Administration (FHA) cash-out refinance

Requirements: You must have a minimum credit score of 600 and a debt-to-income ratio of less than 43%. You must also be able to show that you’ve made all the payments on your current mortgage for the last 12 months or however long you’ve owned the property if it’s less than 12 months.

Max loan limits: For FHA cash-out refinance loans, there is a limit of 85% LTV, which means that you can borrow up to 85% of the home’s current value.

Approval guidelines: To be eligible to refinance, you must have at least 15% equity in your property, according to a current appraisal.

Veterans Administration (VA) cash-out refinance

Requirements: You must have sufficient income and credit history, as well as be able to obtain a certificate of eligibility from the VA. The property must also be used as the primary residence for an eligible veteran or service member. The funds must be used for cash at closing, to pay off debt, to make home improvements or to pay off liens.

Max loan limits: There are no max loan limits on VA cash-out refinance loans.

Approval guidelines: In order to be approved for a certificate of eligibility, the veteran or service member must have been discharged under conditions other than dishonorable. They must also meet length of service requirements for their division of service.

Conclusion

If you’ve already been thinking about refinancing your mortgage and you need some extra funds, doing a cash-out refinance on your home may be a viable option. This allows you to take out more money than you currently owe on your mortgage and use the surplus to cover your expenses.

However, doing so will likely increase your monthly mortgage payment, so it’s best to only use this option to cover costs that are truly important. Talk to your financial advisor to see if cash-out refinancing is the right move for you.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Tara Mastroeni
Tara Mastroeni |

Tara Mastroeni is a writer at MagnifyMoney. You can email Tara here

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Commercial Mortgage Refinancing: How Does It Work?

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In business, there are many reasons why you may want — or need — to look into commercial mortgage refinancing. Maybe your credit score has vastly improved over the last few years and you’re hoping to score a better interest rate, or maybe you’re trying to avoid making a large balloon payment at the end of your current loan term. Regardless of your reasons for wanting to consider a new loan, the process can seem daunting. However, it doesn’t have to be. This guide will walk you through the ins and outs of refinancing a commercial mortgage so that you can make the financing decisions that will work best for you and your business.

Why refinance a commercial loan?

Lower interest rates

The first reason why you may want to refinance a commercial mortgage is to take advantage of lower interest rates. Interest rates are still at relative lows, historically, and if your financial situation has improved since the last time you were approved for a loan, you could be a candidate to take advantage of those lower rates.

Increased cash flow

The main benefit of those lower interest rates is that you’ll have a decreased monthly payment. That lower payment means increased savings, which can be a source of greater cash flow.

On the other hand, you also have the option of doing a cash-out refinance, in which you borrow more money than you currently owe. The excess comes to you as tax-free funds to be used however you wish. Usually, people use this method to undertake big projects like making improvements to the property or funding an expansion.

Better loan terms

Another reason why someone might consider refinancing is to create an opportunity to negotiate more favorable loan terms. This could mean moving from an adjustable-rate mortgage (ARM) to a more stable fixed-rate option or simply tailoring the length of the loan to meet your current needs.

Avoiding balloon payments

Additionally, refinancing your loan could be a way to avoid having to make a sizable balloon payment — a larger-than-usual one-time payment at the end of the loan’s term. Mortgages with balloon payments generally come with lower, sometimes interest-only, payments over the life of the loan. However, when the balance of the loan becomes due, it could amount to thousands of dollars. If you don’t have that amount of cash on hand, refinancing will allow you to extend your repayment window.

What are the borrower requirements to refinance?

In order to get approved for a commercial mortgage, you’ll need to meet certain borrower requirements. Though the exact specifications will vary by lending institution, here’s a general overview of what you can expect:

Repayment ability

First and foremost, lenders want see that you have the ability to actually repay the loan. Typically, this is determined by something called a Debt Service Coverage Ratio (DSCR). It’s found by dividing your business’s net operating income by annual loan payments. In this case, it’s best to shoot for a ratio of 1.2 or more.

Management

Ideally, your business will have a strong management history in order to prove its longevity. For this reason, most lenders limit themselves to businesses that have been operating for two years or more. You may also be asked to show a resume or business plan detailing your experience and future projections.

Equity

In this case, equity refers to the stake that the owner has in the property. In some instances in which the property generates enough income on its own, it can serve as its own collateral. In others, the borrower must put up personal collateral of his or her own.

Credit history

Finally, lenders want to be sure that you have a history of paying off existing debts, so they’ll check your credit score. Be aware that both your business and personal scores may be evaluated.

How does a commercial refinance differ from a home loan refinance?

“Lenders look at this type of loan differently,” said James Hoopes, a senior vice president at NorthMarq Capital in Minneapolis, Minnesota.

“With home loans, your personal credit decides whether or not you get the loan. Here, the amount of income the property produces from its tenants is just as — if not more — important than your credit score.”

In addition to differences in qualifying requirements, Hoopes pointed out that there are huge differences in the way residential and commercial loans get paid off.

“Residential loans tend to amortize over the life of the loan,” he explained, “meaning that the homeowners will have usually paid off the loan in full by the end of the term.”

“Commercial loans, on the other hand, tend to have an amortization period that’s longer than the loan term, which means that borrowers can find themselves facing a large payment when the loan comes due.”

Above all, Hoopes cautions borrowers to think carefully before refinancing their commercial loans. These types of loans come with high penalties that aren’t seen when refinancing traditional home loans.

Types of commercial loans

These days, there are a few distinct types of commercial loans that you can choose from. Be sure to research each one before applying so that you know which type of financing is best for your business.

SBA 7(a) loans

The SBA 7(a) loan is the most common type of small-business loan. The loan is popular because it’s backed by the U.S. Small Business Administration (SBA) and is geared toward serving businesses that might otherwise be turned down by banks. These loans come with a limit of $5 million, and the SBA agrees to back up to 85% of loans up to $150,000 and 75% of those above that amount.

CDC/SBA 504 loans

Another government-backed loan, the CDC/SBA 504 loan is different from the SBA 7(a) loan in the way it’s structured. For this, the SBA will provide 40% of the total project costs, while a Certified Development Company (CDC) will provide an additional 50%, and your down payment will account for the final 10%. Due to its structure, there is no limit on how much you can borrow for CDC/SBA 504 loans; however, the maximum amount that the SBA will provide is $5 million.

Private loans

Private loans are offered by a bank or mortgage company. Traditionally, these loans offer competitively low interest rates. In exchange, however, they typically come with higher qualifying standards in terms of acceptable credit scores and operating histories.

How can you find a lender?

Ideally, you’ll already have a lender in place from the last time you applied for a mortgage. However, if that’s not the case, don’t hesitate to do your own research. Ask your industry contacts who they use for financing, use the SBA website’s free lender match service and read online reviews.

The commercial loan refinancing process

“The first step to refinancing a commercial loan is figuring out what kind of loan you need,” advised Hoopes of NorthMarq Capital. This means taking a close look at why you want to refinance, whether it’s to secure a lower interest rate or to fund renovations via a cash-out option.

The next step is to shop around. “Talk to different lenders in your area to get a sense of what they can offer you. Ask about interest rates, fees and other terms until you find the best proposal for you,” he continued.

From there, it’s all about gathering the right documentation and filling out an application. Every lending institution will have different application requirements. However, in general, you should expect to need the following: a property description, a rent roll, proof of income (profit/loss or revenue/expense statements showing several years of operating history) and the borrower’s resume and financial statements.

“After that, you can enter what’s known as the underwriting period,” Hoopes said. “During this time, the lender will order an appraisal and other third-party reports to determine if you’re eligible to receive the loan.”

“Once the loan has been approved, the lender will issue a loan commitment and, at that point, it’s just a matter of preparing the legal documents for closing,” he concluded.

Fees and closing costs

Not surprisingly, fees can vary from lender to lender, as well; however, two common fees that you should watch out for are prepayment penalties and and a guaranty fee. Prepayment penalties can be hefty and result from paying off your existing mortgage early with your new loan.

For their part, only SBA loans are subject to the guaranty fee. This fee is charged to the lender but is passed along to you for the security of having a government-backed loan. Only the amount of the loan that’s backed by the SBA is taxed, rather than the loan’s face value.

Luckily, closing costs are a bit more predictable. “As a rule of thumb, for loans under $10 million, I would estimate 2% of the loan amount for both closing costs and lender fees, not including legal fees,” Hoopes said. “But they can move up from there.”

The bottom line

At first glance, commercial mortgage refinancing can seem like an overwhelming process, but it doesn’t have to be. With a little bit of research, planning and forethought, you should be able to find a commercial loan that serves your and your business’s needs.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Tara Mastroeni
Tara Mastroeni |

Tara Mastroeni is a writer at MagnifyMoney. You can email Tara here

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