Can you use a home equity loan to pay off your mortgage early?
This is a common question asked by savvy families wanting to own their home for less. This guide will discuss the ways you can use home equity to reduce your monthly payments. Read on for the key details.
First, what’s home equity?
Home equity is an amount of money that you own in your home related to its current market value and existing mortgage debt. To calculate your home equity, you need to take your existing mortgage debt away from the current value of the property. Note that the current value may be a lot different from its value when you purchased the home.
For example, if you bought a £400,000 property with a 20% deposit then your initial home equity is £80,000 (20%). If you proceed to pay off another £100,000 through years of mortgage payments, the home equity will increase to £180,000.
However, home equity can go up or down based on any changes in its value. If the neighbourhood has new amenities and is in high demand, the property value may have soared £50,000 more than its purchase price, giving you an additional £50,000 home equity. It can work the other way too and you could lose equity if the property becomes less valuable due to external factors.
What are home equity loans?
Home equity loans are loans that are tied to the equity in your home. You can take out a loan with a lender relating to the amount of equity in your home, but if you do not make repayments in full or on time, the lender could force you to sell your home to recover their money, known as foreclosure. Although they will likely work with you to avoid this in most situations.
People decide to take out home equity loans for many reasons, such as:
- To consolidate existing debts
- To pay for medical expenses
- To help pay for education
- To pay for big purchases
- To complete home renovations
- To give money to family members who need it
How much can I borrow with a home equity loan?
Most lenders will allow you to borrow up to 80-85% of the equity in your home. For example, if you have £200,000 home equity and you meet the lender’s criteria, you will usually be able to borrow £160,000 to £170,000. Some lenders may let you borrow a little bit more.
Can I use a home equity loan to pay off my mortgage?
It is possible to use a home equity loan to pay off your existing mortgage. Sometimes these loans have a lower interest rate than your existing mortgage, meaning you could save some money by using a home equity loan to pay off your mortgage.
Some people who decide to clear some or all of their mortgage using home equity, do so with a home equity loan, while others use a home equity line of credit, also known as a HELOC.
Paying off a mortgage with a home equity loan
You might be able to take out a home equity loan and access a lump sum to pay off some or all of your existing mortgage. If the interest rate is lower on the home equity loan than your mortgage, you could save on monthly repayments. These loans usually have a fixed interest rate so it’s not difficult to calculate against other fixed-rate mortgages. But you should take into account other fees, such as a home equity loan closing fee which can be around 2-5% of the total loan amount.
You may also want to consider using a HELOC to pay off your mortgage. A HELOC is also a loan based on your home’s equity, but it is provided as revolving credit not dissimilar to the way you access credit from a credit card. The HELOC would be used to make frequent payments towards an ongoing mortgage. This is beneficial if the interest rate is lower than your current mortgage and any home equity loan products. However, it includes an element of risk because HELOCs typically have a variable interest rate that could increase.
Can you pay off a home equity loan with another home equity loan?
If you used a home equity loan to pay off a significant amount of your mortgage or completely pay it off, you might be looking for further ways to reduce your payments. But it would be very difficult to use another home equity loan to pay off an existing home equity loan unless the initial loan was only for a small percentage of your home equity. It will all depend on how much equity is left in your home whether this is possible.
Can you take out a home equity loan on a paid-off house?
You might be able to take out a home equity loan on a home that you have already paid off with no existing mortgage. Lenders providing a home equity loan on a property without an existing mortgage may be more inclined to offer lower interest rates due to decreased risk.
If you were unable to repay the home equity loan and the lender decided to peruse foreclosure (forcing you to sell your home), there would be no other lenders involved and they would more easily get their money back. Thus, you might be able to access a lower interest rate when releasing equity from a home you own outright.
However, homeowners can still be denied home equity loans even when they have no mortgage due to elements of their financial profile.
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