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Loan to value is the percentage of equity value a bank will lend, using your home as collateral. Banks often lend as much as 125 percent LTV to home owners with good credit. Simply put, if the equity in your home is $100,000, a bank might lend you $125,000, using your home as collateral.
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Banks offer two primary home equity lending vehicles:
1) Traditional Home Equity Loan: In this scenario the homeowner borrows a fixed amount, for a specific purpose, and agrees to payment terms over a fixed period of time. This is also known as a second mortgage. A homeowner may take this type of loan to consolidate debt, purchase a vehicle, start a business or fund higher education. The interest paid on this type of loan is frequently tax deductible, making it an attractive option for many borrowers.
2) Home Equity Line of Credit: The HELOC was developed for borrowers wanting more flexibility than a traditional home equity loan typically affords. In this scenario, the bank sets up a credit account, with a limit, that the homeowner can access at will. Typically these credit accounts are accessed by check or with a credit card. Repayment terms are flexible as well, utilizing variable interest rates and monthly minimum payback amounts. Like the traditional home equity loan, the interest paid on a HELOC is frequently tax deductible. -
Make no mistake: home equity loans and lines of credit are second mortgages, and your home is on the line as collateral. If you are unable to make the agreed upon payments, you could lose your home. You need to assess carefully whether the money you are taking out of your home is worth that very real risk.
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If you should should need to file bankruptcy, a primary residence with one mortgage is frequently protected under the law. That protection, however, may not extend to subsequent mortgages and liens.
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Now that you have heard the warnings, there are circumstances where a HELOC or a traditional home equity loan may make sense. These vehicles can relieve financial stress, enabling you to: 1) Avoid bankruptcy by using your equity to consolidate debt. 2) Pay medical expenses. 3) Invest in yourself, through launching a business or obtaining higher education. And 4) Safeguard your credit rating. As with all things, keep your eyes open and balance risks and rewards carefully.
