Home Equity Loans: Preparing for your Custom Los Angeles Dream Home

Posted on August 2, 2021October 28, 2021 by Jason Somers

Building a custom home is a great way to have the final say in how every aspect of your dream home is built and designed. However, there are several things you should be aware of before you begin the process of building your custom home. For instance, building permits are essential if you want to legally build a structure on a plot of land that you own. While the permitting process typically takes weeks to be completed, an expeditor can speed up the process and help you navigate any hurdles that arise while your permit application is being reviewed.

Along with understanding the permitting process and all that it entails, you should also be aware of home equity loans and how they can be useful to you in the future. While you may not need to apply for this kind of loan immediately, it may be necessary at some point after your Los Angeles dream home has been built. Also referred to as a second mortgage, home equity loans provide homeowners with the ability to borrow money by directly leveraging the amount of equity they have in their homes.

As a homeowner, a home equity loan will allow you to borrow as much as $100,000 based on your home’s equity. The interest on this loan can be deducted when you end up filing your taxes. Keep in mind, however, that the ability to deduct the interest on this loan only applies in the event that you use this money for certain home renovations. Before 2018, homeowners could use the money to pay for many different expenses and still deduct the interest when filing their taxes.

One notable benefit of applying for a home equity loan is that the interest rates are relatively low compared to other loan types. Home equity loan rates can be as low as 2% and as high as 7.5%. The following offers a comprehensive guide on home equity loans and why you should know about them when preparing to build your dream home.

How Home Equity Loans Work

If you’re interested in a home equity loan, there are two types of loans that you should be aware of, which include fixed-rate loans and home equity lines of credit.

Fixed-Rate Loans

Fixed-rate loans are common with almost every loan type. When it comes to fixed-rate home equity loans, these loans work by providing homeowners with a single payment that they will be tasked with repaying over a specific period of time. This period of time can be anywhere from 5-15 years at the initial interest rate. Both the interest rate and monthly payment will remain the same over the duration of the loan.

Home Equity Lines of Credit (HELOC)

Home equity lines of credit are variable-rate loans that are similar to credit cards. Many lines of credit will come with a credit card that you can use when you want to make payments with the funds from the line of credit. If you’re approved for this loan, you’ll be given a certain amount of credit that you can use at any point in time within a specific period of time. Money can be withdrawn from the line of credit with a special check or credit card.

Keep in mind that the interest rate with a HELOC loan can vary. As such, your monthly payments will differ depending on the current interest rate and the amount of money that you’ve borrowed from the line of credit. Most of these loans allow borrowers to take money from the line of credit for a period of 5-10 years. The repayment period usually starts once the time limit for the line of credit has expired. This period can be anywhere from 10-20 years, which gives you an ample amount of time to repay the loan.

The main difference between a fixed-rate loan and a variable-rate loan is that the interest rate won’t change with a fixed-rate loan. On the other hand, it can constantly change with a variable-rate loan. While it’s possible that the interest rate will drop over the course of the loan, it could also increase substantially, which would cause your monthly payments to be higher. Some lenders will switch a variable-rate loan over to a fixed-rate loan when the repayment period begins.

Requirements for a Home Equity Loan

Before you apply for a home equity loan, you should understand what requirements you’ll need to meet if you want the application to be approved. While the exact qualification requirements can differ with each lender, there are some general requirements that will likely apply to your situation. First, the amount of equity in your home must be at least 15-20 percent of the home’s market value.

It’s also important that you have a credit score of at least 620 if you want to receive approval. Your debt-to-income ratio must also be at 43% or lower. This ratio is designed to assess how much of your monthly income goes towards the debts that you owe. If the amount of your income that pays off debts each month is less than 43% and you meet all of the other requirements, there’s a good chance that your loan application will be approved.

Keep in mind that the amount of money you receive largely depends on the current value of your home. In order to make sure that the property’s fair market value is correct, your lender might request an appraisal before the application process can be completed. The application process for a home equity loan is fairly quick and can be completed in as little as two weeks.

Benefits for the Consumers vs. the Lenders

Both lenders and consumers can benefit from a home equity loan. For consumers, a home equity loan provides easy access to cash that may have been difficult to otherwise obtain. Even though interest rates for home equity loans are relatively high when compared to rates for conventional mortgages, they are still considerably lower than the rates you’ll find for the majority of credit cards.

Because of the relatively low rates that come with home equity loans, many homeowners will use the loan to pay off some of their credit card balances. By using a home equity loan to pay off any remaining debt, you can consolidate your debt into a single payment that comes with a low-interest rate.

Home equity loans are also highly beneficial to lenders. In fact, they may be more beneficial to lenders than consumers. For a lender, they will have already been receiving monthly mortgage payments from the homeowner to account for the interest rate as well as any fees. The debt that occurs with a home equity loan allows the lender to obtain additional interest payments.

In the event that the borrower defaults on the loan, the lender will be able to keep all of the money that they obtained from the initial loan as well as the home equity loan. The lender is then able to take possession of the property and sell it to a new buyer to begin the process once again. Since the collateral for a home equity loan is the home itself, there’s very little risk of providing the homeowner with the loan.

Pros and Cons for Home Equity Loans

There are many pros and cons that come with obtaining a home equity loan, which you should weigh before making your final decision. While a home equity loan may be ideal for some homeowners, it could be a disaster for others. If you know what you want to do with the money and are in a good financial situation, a home equity loan may be right for you. The main benefits of applying for a home equity loan include:

• Fixed interest rates mean that your monthly payments will always be the same, which makes it easier to create a monthly budget.
• If you want to continue paying your current mortgage interest rate, you can do so.
• The interest could be tax deductible if the loan is used for home renovations and improvements.
• The interest rate could be lower than what you would receive with a credit card or personal loan.

The problems that come with a home equity loan include:

• If you would like to sell your home without having paid back the entire loan, the total loan amount will need to come out of the sale proceeds.
• Ownership of your home could be put in jeopardy if you don’t make your monthly payments.
• A home equity loan doesn’t have as much flexibility as a line of credit.
• Even if you use the loan funds incrementally, interest must be paid on the total loan amount.

The main risk of applying for this type of loan is that your lender could choose to take ownership of your home if you happen to miss a payment due date or stop paying altogether. Home equity loans can be highly useful if you want to have easy access to cash that can be used for a wide range of purposes. However, there’s a substantial risk of applying for this loan, which is why it’s important that you take your time to consider all of the pros and cons before deciding if this type of loan is right for you.