Lenders tend to take this one step further by figuring out your loan to value ratio. This is done by dividing the amount you owe on the home by the current value. This percentage amount is then compared to their standards for issuing loans.
$150,000 divided by $200,000 = 75% loan to value ratio
In most cases, a second mortgage combined with the first home loan should not total more than 75-80% of the overall value of your home. This minimizes the risk to the lender and helps to ensure that you can afford to pay back the loan if you were to default.
Let’s say your lender allows 80% loan to value ratio.
$200,000 x .80 = $160,000 maximum amount allowed
$160,000 less $150,000 current loan amount = $10,000
In this case, you can borrow $10,000 against your equity.
What Is a Second Mortgage?
You may hear of a home equity loan being referred to as a second mortgage. This is because it is simply a new type of home loan that you can apply for after you have earned equity in your home.
A second mortgage uses your home equity as security that you will pay it back. The terms of these loans tend to be shorter than initial mortgages. Most are required to be paid back within 10 to 15 years.
What Is a Home Equity Line of Credit?
A home equity line of credit differs slightly from a second mortgage by not being issued in one lump sum. Instead, you can draw from this line of credit, as needed, over a period of time, such as 5-10 years.
In the first stage of the loan, you will typically only make payments on the interest until it is fully funded. After the initial period is over, it then works like a traditional second mortgage, where you pay on both the interest and the principal.
The advantage of this type of loan is that you have more control over how much money is issued at once.
Using Equity to Increase a Home’s Value
Since your home equity serves as collateral for this loan, it is best to focus on projects that increase its value.
A kitchen or bathroom remodel are common options that bring you a better quality of life, while also making your home more valuable.
Exterior repairs, universal design conversions, and upgrades to home heating and cooling systems are other common reasons why people use their equity to obtain a second home loan.
When done correctly, using home equity loans to increase your home’s value can increase your equity over time. Remember that these loans should always be handled using smart choices, such as making long-term investments in your property.
Our loan specialists can also help you identify strategies to get the best rates on your loan, so that your payment is affordable and you’ll feel good about your decision.