Tapping into Home Equity: Facts vs. Myths
By StoryStudio on September 16, 2024
All around you, people are making significant home improvements or carrying out the remodel of their dreams, however, you might not realize that very few people pay for these renovations out of pocket. Tapping into your home’s equity is a fantastic way to update your home, but it can also help you to afford major expenses, emergencies, or even pay off high-interest debt.
With expert financial advice from Brandy Guzman, Vice President of Branches & Operations at Texas Bay Credit Union, we’ll dive into planning and financing, budgeting strategies, and explore how home equity loans and lines of credit actually work.
A Home Equity Loan vs. a HELOC: Which Is Right for You?
SPONSORED BY Texas bay credit union
Logan Cates
Before determining which type of loan is right for your unique situation, it’s key to first summarize the difference between a home equity loan and a home equity line of credit (HELOC). Both are popular ways to leverage the equity in your home – which in the state of Texas, must be your primary residence – by allowing you to borrow up to 80% of its overall value. However, the two do serve different financial needs.
First, a home equity loan offers a fixed rate and fixed term, making it ideal for those who need a set, lump sum, for specific expenses like debt consolidation, emergency repairs, or home projects. For instance, if you need $20,000 to replace an air conditioning unit, a home equity loan provides a lump sum deposit, and has set, consistent, monthly payments, making budgeting easier. It’s also suitable for fixed expenses like weddings or quinceañeras, where the cost is predictable and can be repaid steadily over time. A big reason people take out a home equity loan is to consolidate debt that has been accumulated over time on various cards or personal loans. The rates and payments are much lower than what they are currently paying, and it is one fixed loan and payment, instead of multiple. This significantly eases financial strain and can help you increase your credit score.
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Budgeting for Home Improvements
Before determining which option fits you best, creating a budget is always going to be the most important step, in meeting any of your financial goals. We have to have a good understanding of how much money we have to work with, how much we will need for certain expenses, and how much we can comfortably afford. When analyzing your financial goals, identify your needs versus your desires. Consider all of your monthly obligations first, to make sure you know how much you can spend on the projects you want or need completed the most.
“The part where people often struggle is not having a plan or idea of how they can accomplish the goal,” Guzman says. “That budget is so important for understanding how you’re going to meet your needs and still accomplish the things that you want to achieve financially. Speaking to your financial partners here at Texas Bay is also a great way to ensure that you are on track.”
There are also multiple apps available that can help with monitoring your spending and adhering to a budget. Utilizing these will allow you to see the big picture of where all of your money is going, and keep you on track for meeting your goals.
Debunking Common Myths
Due to so much misinformation existing about home equity loans and HELOCs, there are a few myths out there that need to be debunked.
Myth #1 – Home equity loans and HELOCs are too risky
A common fear about home equity loans and HELOCs is that using your home as collateral could potentially result in losing your home. However, the reality is that a home equity is a very smart move financially, as long as you have carefully managed your spending and created a budget. The collateral, your home, is simply a safeguard rather than a threat. Lenders are not in the business of foreclosing on homes when borrowers are consistent with their payments. In fact, if you’re already successfully managing other debts like credit cards, using your home equity strategically, could reduce your monthly payments and interest rates significantly, putting you in a much better financial position.
ABOUT TEXAS BAY CREDIT UNION
Founded in 1936, by Houstonians, for Houstonians, Texas Bay works tirelessly to provide the best service to their members and works to find each member a tailor-made solution to help them reach their financial dreams. Visit www.texasbaycu.org for more info, including branch locations and hours of operation.
Since mortgage-related terms are abundant out there, here is a little cheat sheet to ensure you don’t feel as intimidated next time you find yourself in a mortgage discussion.
Lingo and Terms
Principal
Interest rate
Amortization
Escrow
Private Mortgage Insurance (PMI)
Annual Percentage Rate (APR)
Closing costs
Loan-to-Value ratio (LTV)
Mortgage points
Refinancing
Debt-to-Income ratio (DTI)
Understanding these terms is crucial for navigating the mortgage process effectively.
Debt-to-Income ratio (DTI)
What determines someone’s affordability of a home is their DTI. A higher DTI indicates less capacity to afford a mortgage. DTI thresholds vary by loan, typically ranging from 45% to 55%, and can be higher for certain loans like VA loans. DTI calculates monthly credit liabilities, including credit cards, student loans, and car loans, along with the desired mortgage, comparing this total to gross monthly income. The resulting percentage reflects the DTI ratio and ultimately determines your affordability.
Interest rate
This rate is determined by the lender, and it’s usually based on what the market’s going interest rate is at the time. This is the way to calculate exactly how much interest you have to pay on that loan monthly and over the life of the entire loan.
Escrow
Escrow is essentially a non-interest-bearing holding account for money to be placed in and then used at a later date. Money that you pay each month will go into a specific escrow account and be used towards your taxes and your insurance. The servicer or the lender is going to hold that money for you, and when the bill is due, they will make that payment on your behalf. Note, there is no interest charged on escrow accounts.
Annual Percentage Rate (APR)
Contrary to what many believe, APR is not the interest rate. APR is actually another way to express some of the costs of the loan compared to the interest rate over the first year of the loan. In other words, APR is just another way to look at the closing costs of the loan in a percentage form, but it is not the interest rate.
Closing costs
Closing costs typically consist of three main components:
Loan-to-Value ratio (LTV)
LTV is the relationship between the loan amount and the appraised value or sales price of a property. This is calculated using the lesser of the sales price or the appraised value. For instance, if the sales price is $100,000 but the appraised value is $95,000, the LTV is based on the lower value of $95,000.
Mortgage points
Also known as discount points, mortgage points are payments made to lower the interest rate on a mortgage. Contrary to common belief, paying one point doesn’t always equate to a one-point reduction in the interest rate. The relationship between points and interest rates is determined by investors in the mortgage market. Buying down to a lower rate may require paying multiple points, as investors may prefer higher interest rates. Points can range from fractions of a point to whole percentages, depending on investor preferences.
Refinancing
There are a couple of different ways you can refinance a mortgage loan. The first is a rate and term refinance where you’re just refinancing to get a better interest rate or to lower your term, meaning you’re going from a 30-year loan to a 25 or a 20 to a 10, which is a no cash-out refinance. Then there’s also a cash-out refinance, which is what most people think of as a home equity loan where you’re getting equity out of your home in the form of cash to use for the expense of your choosing.
Lender charges are fees imposed by the lender for processing the loan.
Various third-party charges, such as the appraisal, credit report, title company fees, and recording charges.
Escrow account setup charges, if applicable, which involve setting aside funds for future payments like property taxes and insurance. These are sometimes referred to as “cushions” rather than direct fees.
1)
2)
3)
Private Mortgage Insurance (PMI)
A common misconception about private mortgage insurance is that it protects the buyer. In reality, private mortgage insurance is for the lender or the servicer to protect them in case of default. If someone’s making a lower down payment – under 20% – the borrowers will have no choice but to pay PMI.
Amortization
Amortization determines the payment structure of a loan, dividing it over its entire lifespan into monthly payments covering both principal and interest. Initially, more of the payment goes towards interest, with less going towards principal, but over time this flips to the opposite. Fixed-rate loans maintain consistent monthly payments, with the allocation between principal and interest gradually changing until the loan is fully paid off.
Principal
The principal is what you actually owe on the loan – in other words, whatever the sales price is of the home, minus your down payment.
Myth #2 – The approval process is too complicated
Lenders consider simple factors like your payment history, deposit history, and the value of your property. This makes home equity loans and HELOCs pretty straightforward. “I’ve personally used home equity myself for projects on my home and for debt consolidation,” Guzman comments. “Our team here is so great about guiding you through every step of the process, so there’s really nothing to fear.”
Myth #3 – Home equity loans are only for large projects
Another misconception is that home equity loans or HELOCs are only beneficial for large projects. While these loans are certainly helpful for significant home renovations, and can provide more cash than a personal loan, they are equally useful for smaller expenses or debt consolidation. For example, borrowers can secure as little as $10,000 for a wide range of needs, including emergency repairs, medical bills, or even smaller home improvements. Once approved, you have complete flexibility in how you use the funds, regardless of the project size.
No One Goes Above and Beyond Quite Like Texas Bay
If there is one thing that Texas Bay Credit Union is, it’s passionate about helping others. Every credit union might love their members, yet the team at Texas Bay goes above and beyond to be everyone’s trusted financial partner. This approach entails treating the customers’ aspirations as their own.
“We will dig to find out what goals they truly have, even the ones they think maybe they can’t achieve at this time, and we’re going to find a way to help them accomplish them now or put them on the path to do so in the future,” says VP Brandy Guzman.
As fall hits and the end of the year begins to rapidly approach, everyone will continue thinking about how to best get their finances in order. Leveraging home equity is an unbeatable way to either pay off pesky debts or finish some of those coveted home projects to get ready for the holidays.
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In contrast, a HELOC is a revolving line of credit, more flexible for projects with variable costs or those stretched out over time, like home renovations. For example, if you’re planning to remodel your home in phases over a few years, a HELOC allows you to withdraw funds as needed. This is beneficial because initially, you’re only obligated to pay the interest on what you’ve used, which can be advantageous. After the initial draw period, which at a credit union like Texas Bay is 5 years, the remaining balance converts to a fixed-rate loan, locking in the rate for the repayment period. At that time you become responsible for paying the principal and interest for the remainder of the term.
Fortunately, both home equity loans and HELOCs typically offer lower interest rates than unsecured loans, like personal loans or credit cards, because they’re secured by your home. For those with significant equity, these options provide a cost-effective way to borrow, with rates often far below what you’d pay for unsecured debt.
“The people that I’m going to recommend a home equity loan to are people who are trying to get out of debt or have an emergency expense,” Guzman advises. “If you’re going to remodel your home, a HELOC is better, because not many people gut their home all at once. You have the flexibility for home projects to take the money out as you need it, and can take more time finding the right contractors and the best prices.”
At the end of the day, a home equity loan is best for fixed expenses, while a HELOC is more suited for ongoing, variable expenses. Tax benefits may also be available for both options, but it’s advisable to consult a tax professional to understand specific implications for your situation.
Myth #4 – You need perfect credit to qualify
While credit history is important, factors like good payment consistency, the value of your home, and even what you may be paying off with the loan, all play significant roles in the decision. “You don’t need to have perfect credit,” Guzman states. “Even if you’ve had a few hiccups in the past, this is a great way to be able to get approved for a loan you need, because there is collateral, and the payments are generally lower than personal loans.”
Tapping into Home Equity: Facts vs. Myths
It’s about time someone addresses all of the common misconceptions regarding home equity loans and HELOCs. Do you think you have the right answers? By answering these 8 simple questions, you’ll either verify your own knowledge or realize some details you never knew!
Get Started
What do both a home equity loan and a HELOC allow you to do?
Question 1 of 8
Borrow against the value of your vehicle
Utilize the equity in your home
Get access to exclusive golf courses
Obtain a loan with no collateral
Utilize the equity in your home
Next Question
Borrow against the value of your vehicle
Get access to exclusive golf courses
Obtain a loan with no collateral
Question 2 of 8
You can only use home equity loans for home improvement projects.
True
False
True
False
Next Question
Question 3 of 8
In Texas, what type of property must a home equity loan or HELOC be used on?
Primary residence
Vacation home
Rental property
All of the above
Vacation home
Rental property
All of the above
Primary residence
Next Question
Question 4 of 8
What percentage of your home’s value can typically be accessed with a home equity loan or HELOC in Texas?
50%
65%
80%
90%
80%
65%
50%
90%
Next Question
Question 5 of 8
What is a key feature of a HELOC compared to a home equity loan?
No defined repayment term
Lump sum disbursement
Ongoing line of credit
Free margaritas when approved
Ongoing line of credit
Lump sum disbursement
No defined repayment term
Free margaritas when approved
Next Question
Question 6 of 8
For which item can you use a HELOC?
Paying for emergency expenses
Funding phased home improvement projects
Consolidating debt
All of the above
All of the above
Funding phased home improvement projects
Paying for emergency expenses
Consolidating debt
Next Question
Question 7 of 8
Which type of loan allows you to only pay interest during the initial draw period?
Home equity loan
Personal loan
Taylor Swift tickets loan
HELOC
HELOC
Personal loan
Home equity loan
Taylor Swift tickets loan
Next Question
Question 8 of 8
How will your credit score be impacted by taking out a home equity loan or HELOC?
It always decreases your score by 50 points
It only lowers your credit score if you miss payments
Your score drops no matter what
These loans never appear on your credit report
It always decreases your score by 50 points
Your score drops no matter what
These loans never appear on your credit report
It only lowers your credit score if you miss payments
Restart Quiz
Logan Cates
Lingo and Terms
Since mortgage-related terms are abundant out there, here is a little cheat sheet to ensure you don’t feel as intimidated next time you find yourself in a mortgage discussion.
Principal
Interest rate
Amortization
Escrow
Private Mortgage Insurance (PMI)
Annual Percentage Rate (APR)
Closing costs
Loan-to-Value ratio (LTV)
Mortgage points
Refinancing
Debt-to-Income ratio (DTI)
Principal
The principal is what you actually owe on the loan – in other words, whatever the sales price is of the home, minus your down payment.
Interest rate
This rate is determined by the lender, and it’s usually based on what the market’s going interest rate is at the time. This is the way to calculate exactly how much interest you have to pay on that loan monthly and over the life of the entire loan.
Amortization
Amortization determines the payment structure of a loan, dividing it over its entire lifespan into monthly payments covering both principal and interest. Initially, more of the payment goes towards interest, with less going towards principal, but over time this flips to the opposite. Fixed-rate loans maintain consistent monthly payments, with the allocation between principal and interest gradually changing until the loan is fully paid off.
Escrow
Escrow is essentially a non-interest-bearing holding account for money to be placed in and then used at a later date. Money that you pay each month will go into a specific escrow account and be used towards your taxes and your insurance. The servicer or the lender is going to hold that money for you, and when the bill is due, they will make that payment on your behalf. Note, there is no interest charged on escrow accounts.
Private Mortgage Insurance (PMI)
A common misconception about private mortgage insurance is that it protects the buyer. In reality, private mortgage insurance is for the lender or the servicer to protect them in case of default. If someone’s making a lower down payment – under 20% – the borrowers will have no choice but to pay PMI.
Annual Percentage Rate (APR)
Contrary to what many believe, APR is not the interest rate. APR is actually another way to express some of the costs of the loan compared to the interest rate over the first year of the loan. In other words, APR is just another way to look at the closing costs of the loan in a percentage form, but it is not the interest rate.
Closing costs
Closing costs typically consist of three main components:
Lender charges are fees imposed by the lender for processing the loan.
Various third-party charges, such as the appraisal, credit report, title company fees, and recording charges.
Escrow account setup charges, if applicable, which involve setting aside funds for future payments like property taxes and insurance. These are sometimes referred to as “cushions” rather than direct fees.
1)
2)
3)
Loan-to-Value ratio (LTV)
LTV is the relationship between the loan amount and the appraised value or sales price of a property. This is calculated using the lesser of the sales price or the appraised value. For instance, if the sales price is $100,000 but the appraised value is $95,000, the LTV is based on the lower value of $95,000.
Mortgage points
Also known as discount points, mortgage points are payments made to lower the interest rate on a mortgage. Contrary to common belief, paying one point doesn’t always equate to a one-point reduction in the interest rate. The relationship between points and interest rates is determined by investors in the mortgage market. Buying down to a lower rate may require paying multiple points, as investors may prefer higher interest rates. Points can range from fractions of a point to whole percentages, depending on investor preferences.
Refinancing
There are a couple of different ways you can refinance a mortgage loan. The first is a rate and term refinance where you’re just refinancing to get a better interest rate or to lower your term, meaning you’re going from a 30-year loan to a 25 or a 20 to a 10, which is a no cash-out refinance. Then there’s also a cash-out refinance, which is what most people think of as a home equity loan where you’re getting equity out of your home in the form of cash to use for the expense of your choosing.
Debt-to-Income ratio (DTI)
What determines someone’s affordability of a home is their DTI. A higher DTI indicates less capacity to afford a mortgage. DTI thresholds vary by loan, typically ranging from 45% to 55%, and can be higher for certain loans like VA loans. DTI calculates monthly credit liabilities, including credit cards, student loans, and car loans, along with the desired mortgage, comparing this total to gross monthly income. The resulting percentage reflects the DTI ratio and ultimately determines your affordability.
Understanding these terms is crucial for navigating the mortgage process effectively.
Brandy Guzman
