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A HOUSING LOAN is a type of loan in which the borrower uses the equity of his or her home as collateral. Home equity loans are often used to finance major expenses such as home repairs, medical bills, or college education. A home equity loan creates a lien against the borrower's house and reduces actual home equity.
Most home equity loans require good to excellent credit history, reasonable loan-to-value and combined loan-to-value ratios. Home equity loans come in two types: closed end (traditionally just called a home-equity loan) and open end (aka a home-equity line of credit). Both are usually referred to as second mortgages, because they are secured against the value of the property, just like a traditional mortgage. Home equity loans and lines of credit are usually, but not always, for a shorter term than first mortgages. Home equity loan can be used as a person's main mortgage in place of a traditional mortgage. However, one can not purchase a home using a home equity loan, one can only use a home equity loan to refinance. In the United States, in most cases it is possible to deduct home equity loan interest on one's personal income taxes.
There is a specific difference between a home equity loan and a home equity line of credit (HELOC). A HELOC is a line of revolving credit with an adjustable interest rate whereas a home equity loan is a one time lump-sum loan, often with a fixed interest rate. With a HELOC the borrower can choose when and how often to borrow against the equity in the property, with the lender setting an initial limit to the credit line based on criteria similar to those used for closed-end loans. Like the closed-end loan, it may be possible to borrow up to an amount equal to the value of the home, minus any liens. These lines of credit are available up to 30 years, usually at a variable interest rate. The minimum monthly payment can be as low as only the interest that is due. Typically, the interest rate is based on the prime rate plus a margin.
Home equity is the market value of a homeowner's unencumbered interest in their real property—that is, the difference between the home's fair market value and the outstanding balance of all liens on the property. The property's equity increases as the debtor makes payments against the mortgage balance, and/or as the property value appreciates. In economics, home equity is sometimes called real property value.
Home equity is not liquid. Home equity management refers to the process of using equity extraction via loans—at favorable, and often tax-favored, interest rates—to invest otherwise illiquid equity in a target that offers higher returns.
Homeowners acquire equity in their home from two sources. They purchase equity with their down payment, and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. Investors typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.
Home equity may serve as collateral for a home equity loan or home equity line of credit (HELOC). Many home equity plans set a fixed period during which the person can borrow money, such as 10 years. At the end of this “draw period,” the person may be allowed to renew the credit line. If the plan does not allow renewals, the person will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, 10 years.
A home equity line of credit (often called HELOC and pronounced Hee-lock) is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower's equity in his/her house (akin to a second mortgage). Because a home often is a consumer's most valuable asset, many homeowners use home equity credit lines only for major items, such as education, home improvements, or medical bills, and choose not to use them for day-to-day expenses. HELOC abuse is often cited as one cause of the subprime mortgage crisis.
Differences from conventional loans
A HELOC differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit, similar to a credit card. HELOC funds can be borrowed during the "draw period" (typically 5 to 25 years). Repayment is of the amount drawn plus interest. A HELOC may have a minimum monthly payment requirement (often "interest only"); however, the debtor may make a repayment of any amount so long as it is greater than the minimum payment (but less than the total outstanding). The full principal amount is due at the end of the draw period, either as a lump-sum balloon payment or according to a loan amortization schedule.[4]
Another important difference from a conventional home equity loan is that the interest rate on a HELOC is variable. The interest rate is generally based on an index, such as the prime rate. This means that the interest rate can change over time. Homeowners shopping for a HELOC must be aware that not all lenders calculate the margin the same way. The margin is the difference between the prime rate and the interest rate the borrower will actually pay.
HELOC loans became very popular in the United States in the early 2000s, in part because interest paid is typically deductible under federal and many state income tax laws.[citation needed] This effectively reduced the cost of borrowing funds and offered an attractive tax incentive over traditional methods of borrowing such as credit cards. Another reason for the popularity of HELOCs is their flexibility, both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans' popularity may also stem from their having a better image than a "second mortgage," a term which can more directly imply an undesirable level of debt.[5] However, within the lending industry itself, a HELOC is categorized as a second mortgage.
Because the underlying collateral of a home equity line of credit is the home, failure to repay the loan or meet loan requirements may result in foreclosure. As a result, lenders generally require that the borrower maintain a certain level of equity in the home as a condition of providing a home equity line.
Traditional mortgages in the United States are usually non-recourse loans, while mortgages in countries such as Canada are generally recourse loans. "Nonrecourse debt or a nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable." A HELOC may be a recourse loan for which the borrower is personally liable. This distinction becomes important in foreclosure since the borrower may remain personally liable for a recourse debt on a foreclosed property.
HELOC freeze
In 2008 major home equity lenders including Bank of America, Countrywide Financial, Citigroup, JP Morgan Chase, National City Mortgage, Washington Mutual and Wells Fargo began informing borrowers that their home equity lines of credit had been frozen, reduced, suspended, rescinded or restricted in some other manner.[6][7][8] Falling housing prices have led to borrowers possessing reduced equity, which is perceived as an increased risk of foreclosure in the eyes of lenders. On January 27, 2010, a federal judge refused to dismiss a class action lawsuit against Chase for freezing HELOC loans.[9] Courts have held that a bank may freeze a HELOC in instances where a home's value decreases substantially, which is deemed by courts as a 50% reduction in value.
A Reverse Mortgage or Home Equity Conversion Mortgage (HECM) is a special type of home loan for older homeowners that requires no monthly mortgage payments. Borrowers are still responsible for property taxes and homeowner’s insurance. Reverse mortgages allow elders to access the home equity they have built up in their homes now, and defer payment of the loan until they die, sell, or move out of the home. Because there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. However, the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home.[Specific rules for reverse mortgage transactions vary depending on the laws of the jurisdiction.
In a conventional mortgage, the homeowner makes a monthly payment to the lender. After each payment, the homeowner's equity increases by the amount of the principal included in the payment. In a reverse mortgage, a homeowner is not required to make monthly payments. If payments are not made, interest is added to the loan's balance. Although the "rising loan balance can eventually grow to exceed the value of the home," "the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home." In Canada, the loan balance cannot exceed the fair market value of the home by law.
Regulators and academics have given mixed commentary on the reverse mortgage market. Some economists argue that reverse mortgages allow the elderly to smooth out their income and consumption patterns over time, and thus may provide welfare benefits. However, regulatory authorities, such as the Consumer Financial Protection Bureau, argue that reverse mortgages are "complex products and difficult for consumers to understand," especially in light of "misleading advertising," low-quality counseling, and "risk of fraud and other scams." Moreover, the Bureau claims that many consumers do not use reverse mortgages for the positive, consumption-smoothing purposes advanced by economists. In Canada, the borrower must seek independent legal advice before being approved for a reverse mortgage.
Reverse mortgages are available in Australia. However, there is little regulation: the Financial Services Reform Act does not regulate the loans,[4] and although potential borrowers should seek financial advice before applying for a reverse mortgage, there is no legislation that requires the advisor to be licensed.[4]
Eligibility requirements vary by lender. To qualify for a reverse mortgage in Australia,
the borrower must be over a certain age, usually 60 or 65 years of age; if the mortgage has more than one borrower, the youngest borrower must meet the age requirement
the borrower must own the property, or the existing mortgage balance must be low enough that it will be paid off with the reverse mortgage proceeds
Reverse mortgages in Australia can be as high as 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:
the borrower's age, with a higher amount available at a higher age
current interest rates
property value
the property's location
program minimum and maximum; for example, the loan might be constrained to a minimum of $10,000 and a maximum of 425,000
The cost of getting a reverse mortgage depends on the particular reverse mortgage program the borrower acquires. These costs are frequently rolled into the loan itself and therefore compound with the principal. Typical costs for the reverse mortgage include:
an application fee (establishment fee) = $950
stamp duty, mortgage registration fees, and other government charges = vary with location
The interest rate on the reverse mortgage varies. Some programs offer fixed rate loans, while others offer variable rate loans.
In addition, there are costs during the life of the reverse mortgage. A monthly service charge may be applied to the balance of the loan (for example, $12 per month), which then compounds with the principal
Most home equity loans require good to excellent credit history, reasonable loan-to-value and combined loan-to-value ratios. Home equity loans come in two types: closed end (traditionally just called a home-equity loan) and open end (aka a home-equity line of credit). Both are usually referred to as second mortgages, because they are secured against the value of the property, just like a traditional mortgage. Home equity loans and lines of credit are usually, but not always, for a shorter term than first mortgages. Home equity loan can be used as a person's main mortgage in place of a traditional mortgage. However, one can not purchase a home using a home equity loan, one can only use a home equity loan to refinance. In the United States, in most cases it is possible to deduct home equity loan interest on one's personal income taxes.
There is a specific difference between a home equity loan and a home equity line of credit (HELOC). A HELOC is a line of revolving credit with an adjustable interest rate whereas a home equity loan is a one time lump-sum loan, often with a fixed interest rate. With a HELOC the borrower can choose when and how often to borrow against the equity in the property, with the lender setting an initial limit to the credit line based on criteria similar to those used for closed-end loans. Like the closed-end loan, it may be possible to borrow up to an amount equal to the value of the home, minus any liens. These lines of credit are available up to 30 years, usually at a variable interest rate. The minimum monthly payment can be as low as only the interest that is due. Typically, the interest rate is based on the prime rate plus a margin.
Home equity is the market value of a homeowner's unencumbered interest in their real property—that is, the difference between the home's fair market value and the outstanding balance of all liens on the property. The property's equity increases as the debtor makes payments against the mortgage balance, and/or as the property value appreciates. In economics, home equity is sometimes called real property value.
Home equity is not liquid. Home equity management refers to the process of using equity extraction via loans—at favorable, and often tax-favored, interest rates—to invest otherwise illiquid equity in a target that offers higher returns.
Homeowners acquire equity in their home from two sources. They purchase equity with their down payment, and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. Investors typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.
Home equity may serve as collateral for a home equity loan or home equity line of credit (HELOC). Many home equity plans set a fixed period during which the person can borrow money, such as 10 years. At the end of this “draw period,” the person may be allowed to renew the credit line. If the plan does not allow renewals, the person will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, 10 years.
A home equity line of credit (often called HELOC and pronounced Hee-lock) is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower's equity in his/her house (akin to a second mortgage). Because a home often is a consumer's most valuable asset, many homeowners use home equity credit lines only for major items, such as education, home improvements, or medical bills, and choose not to use them for day-to-day expenses. HELOC abuse is often cited as one cause of the subprime mortgage crisis.
Differences from conventional loans
A HELOC differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit, similar to a credit card. HELOC funds can be borrowed during the "draw period" (typically 5 to 25 years). Repayment is of the amount drawn plus interest. A HELOC may have a minimum monthly payment requirement (often "interest only"); however, the debtor may make a repayment of any amount so long as it is greater than the minimum payment (but less than the total outstanding). The full principal amount is due at the end of the draw period, either as a lump-sum balloon payment or according to a loan amortization schedule.[4]
Another important difference from a conventional home equity loan is that the interest rate on a HELOC is variable. The interest rate is generally based on an index, such as the prime rate. This means that the interest rate can change over time. Homeowners shopping for a HELOC must be aware that not all lenders calculate the margin the same way. The margin is the difference between the prime rate and the interest rate the borrower will actually pay.
HELOC loans became very popular in the United States in the early 2000s, in part because interest paid is typically deductible under federal and many state income tax laws.[citation needed] This effectively reduced the cost of borrowing funds and offered an attractive tax incentive over traditional methods of borrowing such as credit cards. Another reason for the popularity of HELOCs is their flexibility, both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans' popularity may also stem from their having a better image than a "second mortgage," a term which can more directly imply an undesirable level of debt.[5] However, within the lending industry itself, a HELOC is categorized as a second mortgage.
Because the underlying collateral of a home equity line of credit is the home, failure to repay the loan or meet loan requirements may result in foreclosure. As a result, lenders generally require that the borrower maintain a certain level of equity in the home as a condition of providing a home equity line.
Traditional mortgages in the United States are usually non-recourse loans, while mortgages in countries such as Canada are generally recourse loans. "Nonrecourse debt or a nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable." A HELOC may be a recourse loan for which the borrower is personally liable. This distinction becomes important in foreclosure since the borrower may remain personally liable for a recourse debt on a foreclosed property.
HELOC freeze
In 2008 major home equity lenders including Bank of America, Countrywide Financial, Citigroup, JP Morgan Chase, National City Mortgage, Washington Mutual and Wells Fargo began informing borrowers that their home equity lines of credit had been frozen, reduced, suspended, rescinded or restricted in some other manner.[6][7][8] Falling housing prices have led to borrowers possessing reduced equity, which is perceived as an increased risk of foreclosure in the eyes of lenders. On January 27, 2010, a federal judge refused to dismiss a class action lawsuit against Chase for freezing HELOC loans.[9] Courts have held that a bank may freeze a HELOC in instances where a home's value decreases substantially, which is deemed by courts as a 50% reduction in value.
A Reverse Mortgage or Home Equity Conversion Mortgage (HECM) is a special type of home loan for older homeowners that requires no monthly mortgage payments. Borrowers are still responsible for property taxes and homeowner’s insurance. Reverse mortgages allow elders to access the home equity they have built up in their homes now, and defer payment of the loan until they die, sell, or move out of the home. Because there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. However, the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home.[Specific rules for reverse mortgage transactions vary depending on the laws of the jurisdiction.
In a conventional mortgage, the homeowner makes a monthly payment to the lender. After each payment, the homeowner's equity increases by the amount of the principal included in the payment. In a reverse mortgage, a homeowner is not required to make monthly payments. If payments are not made, interest is added to the loan's balance. Although the "rising loan balance can eventually grow to exceed the value of the home," "the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home." In Canada, the loan balance cannot exceed the fair market value of the home by law.
Regulators and academics have given mixed commentary on the reverse mortgage market. Some economists argue that reverse mortgages allow the elderly to smooth out their income and consumption patterns over time, and thus may provide welfare benefits. However, regulatory authorities, such as the Consumer Financial Protection Bureau, argue that reverse mortgages are "complex products and difficult for consumers to understand," especially in light of "misleading advertising," low-quality counseling, and "risk of fraud and other scams." Moreover, the Bureau claims that many consumers do not use reverse mortgages for the positive, consumption-smoothing purposes advanced by economists. In Canada, the borrower must seek independent legal advice before being approved for a reverse mortgage.
Reverse mortgages are available in Australia. However, there is little regulation: the Financial Services Reform Act does not regulate the loans,[4] and although potential borrowers should seek financial advice before applying for a reverse mortgage, there is no legislation that requires the advisor to be licensed.[4]
Eligibility requirements vary by lender. To qualify for a reverse mortgage in Australia,
the borrower must be over a certain age, usually 60 or 65 years of age; if the mortgage has more than one borrower, the youngest borrower must meet the age requirement
the borrower must own the property, or the existing mortgage balance must be low enough that it will be paid off with the reverse mortgage proceeds
Reverse mortgages in Australia can be as high as 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:
the borrower's age, with a higher amount available at a higher age
current interest rates
property value
the property's location
program minimum and maximum; for example, the loan might be constrained to a minimum of $10,000 and a maximum of 425,000
The cost of getting a reverse mortgage depends on the particular reverse mortgage program the borrower acquires. These costs are frequently rolled into the loan itself and therefore compound with the principal. Typical costs for the reverse mortgage include:
an application fee (establishment fee) = $950
stamp duty, mortgage registration fees, and other government charges = vary with location
The interest rate on the reverse mortgage varies. Some programs offer fixed rate loans, while others offer variable rate loans.
In addition, there are costs during the life of the reverse mortgage. A monthly service charge may be applied to the balance of the loan (for example, $12 per month), which then compounds with the principal
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