If you’ve been shopping around for a second mortgage—a long-term loan based on the value and equity in your home—you may have run across offers for a 125% home equity loan, but if you’re like many people, you may be a bit confused about what this means. If so, your worries are over. Here we will describe what a home equity loan is all about, and how certain lenders can afford to offer you 125 % of your equity.
A home equity loan is different than other types of loans. With a traditional loan, such as a first mortgage, auto loan or small business loan your credit score and proof of credit worthiness is extremely important, and while this is also a factor in determining eligibility for a home equity loan, it is not the primary prerequisite. What is primary is the amount of equity in your home as well as your home’s value.
When you apply for a home equity loan, the lender will try to determine how much your house is actually worth, minus what you currently owe on your first mortgage. This balance is sometimes called the “cash out balance,” or more simply, the net amount of cash you could reasonably expect to receive if you were to sell your home on the open market. When you apply for a home equity loan, your equity serves as the collateral in case you fail to make your payments, and since there is less risk for the lender, they are usually able to offer you a very competitive rate and are not as preoccupied with your credit history.
So now you know the basics of how a home equity loan works, but what about a 125% home equity loan. How can a lender offer you a loan worth more than your current equity, and if they do, where’s the security for the lender? The answer is that they’re counting on the future. Your home—at least relying on historical trends—is not a liability as some other purchases are (cars, boats, etc) but an investment, and over time you can reasonably expect that your home will increase in value. And as it does, so does the amount of equity. Lenders know this—are in fact counting on it—and that’s why they can extend you a 125% home equity loan. They know that through a combination of appreciation and the payments you will continue to make on your home, the equity you hold will continue to rise.
It really is that simple. And perhaps the best part of a 125% home equity loan—aside from being completely tax deductible—is that you can use the money for any purpose you want. As long as you agree to make the monthly payments—an amount usually spread over 10-15 years—you’re free to spend the money how you wish.
If you’re currently in the market for a second mortgage, be sure to ask your lender about a 125% home equity loan. In most cases, it truly is a great deal.