There are many different types of personal loans available from banks and other lenders that are based on home ownership. All of them are in some way tied to the value of your home and the equity you hold, but not all of them are intended to be used for the purchase or upgrade of that home. Following are some home-based loan types and some general information about each.
Home Loan / MortgageLoan
A Home Loan is a loan provided to you by your bank or other lending institution that provides some percentage of the price of a new or existing home as payment to the current owner on your behalf. In exchange, you agree to repay the loan to the lender over a period of years at an agreed rate of interest, either a fixed percentage over the term of the loan or a variable percentage based upon market conditions. The home being purchased is used as security for the lender in this type of loan. That security is known as a mortgage. If you do not repay according to the agreed-upon schedule, the lender may repossess the home through the foreclosure process. The key to good budgeting and financial planning for an individual or family is to understand the full terms of the loan before agreeing to be bound by it.
Fixed rate loans provide easier budgeting, since the payment amount never varies during the length of the loan.Your monthly payment will remain consistent for as many years as it takes to pay off the balance. However, any amounts escrowed for taxes and insurance on the property may go up from year to year as property taxes and insurance costs rise, sometimes substantially. With an adjustable rate mortgage (ARM) you may have lower payments initially, making it possible to afford a home now with lower payments than would be possible with a fixed-rate loan. However, the payments for an ARM will fluctuate over the course of the loan, depending upon interest rates andthe terms of the loan. This makes it much more difficult to budget, and shouldbe considered only if the borrower is confident in their ability to repay theloan even if payments increase significantly.
A Refinance Loan is a home loan entered into to replace your current home loan. With a refinance, your existing loan is paid in full, and the refinance loan takes it splace. There are many reasons for refinancing, such as to lower your interes trate, restructure from an adjustable rate to a fixed rate, consolidate debts into one monthly payment, or to extend the home loan out to a longer term,reducing monthly cash outlays. There are usually closing costs associated witha refinance (as with any home loan) and the homeowner needs to be aware of how those costs weigh into the overall repayment cost of the loan. Frequent refinancing with the goal of reducing the interest rate by a minimal amount might not be as beneficial as initially thought once those costs are included in the overall repayment amount. However if a much lower interest rate is available, refinancing can be an excellent decision to save money on interestover the course of the loan.
A Construction Loanis an option if you are planning to have your home built. It has a few majordifferences from a traditional home loan. Many construction loans arestructured for the short term, and intended to be paid off when theconstruction of the home is complete. At that point the homeowner wouldgenerally refinance to a traditional home loan, which would include the processofloan qualification and the expense of closing costs. But there are alsolenders who offer a construction rollover loan so that the construction loanwould automatically convert into a traditional loan after the certificate ofoccupancy on the house is received; one closing process and one closing costamount. Many construction loans offer interest-only payments during theconstruction period. Some may offer terms including no payments duringconstruction. This is handled by adding on the cost of the interest for theduration of the construction to the balance due on the loan. Since constructionloans offer quite a lot of flexibility in terms, make sure you are familiarwith what your banker is offering before choosing the correct construction loanterms for your situation.
A Home ImprovementLoan is a loan secured to finance the cost of making improvements to yourexisting home, such as updating your kitchen, repairing a faulty roof or addingon a family room or a second level. The goal of any such improvement istypically to increase the overall value of your home, and the cost of theimprovement should be weighed according to the value gained. In other words,when considering what upgrades to make, think about the current value of yourhome if you were to sell now. Add on the improvement and determine whether thatwould make a difference in the price you could expect to receive when selling.Does the added value exceed the cost of the improvement? Resale is an importantfactor in making home improvements, but it is not the only variable. It isdifficult to put a price on the extra enjoyment to be gained by you and yourfamily for certain improvements made; a workout room,extra bathroom, playroomor kitchen upgrade could "pay for itself” in reduced stress levels or increasedleisure time. Homeimprovement loans are typically shorter-term than home loans, but checkwith your banker as many banks offer flexible terms and attractive paymentschedules.
Home Equity Loan
A Home Equity Loanis based upon the current value of your home and the equity that you currentlyhave in that home. Although it is secured by your home, the uses for this typeof loan can be anything from financing college tuition, paying off medicalbills or taking the vacation of a lifetime. The equity that you have in yourhome serves as security for the loan, which often results in interest rates andterms more favorable to the borrower than traditional consumer loans or creditcards. In many cases, the interest paid on a home equity loan is taxdeductible. Homeequity loans can be structured as traditional loans with fixed interestrates, with repayment periods that vary depending upon the size of the loan.They can also be structured as a line of credit available to the home owner, andthe line of credit also typically has a variable interest rate and a set termand must be paid in full at the end of that term. Lines of credit often workexactly like a credit card as the homeowner uses the card to make purchases asneeded. In either case, the home equity loan is only available during the timethe home is owned by the borrower; once the home is sold the home equity loanbecomes due.
Depending upon your goals and your currentsituation, securing some type of "home loan” may be beneficial. Whether yourimmediate future includes the purchase of your first home, adding on an extrabedroom or borrowing to help pay for college expenses, your banker can help youto understand the advantages to home loans now, and for your financial future.