Financial Fitness: Different Home Loan Types

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.

 

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. 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 and the terms of the loan. This makes it much more difficult to budget, and should be considered only if the borrower is confident in their ability to repay the loan 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 its place. There are many reasons for refinancing, such as to lower your interest rate, 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 with a 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 interest over the course of the loan.

 

A Construction Loan is an option if you are planning to have your home built. It has a few major differences from a traditional home loan. Many construction loans are structured for the short term, and intended to be paid off when the construction of the home is complete. At that point the homeowner would generally refinance to a traditional home loan, which would include the process ofloan qualification and the expense of closing costs. But there are also lenders who offer a construction rollover loan so that the construction loan would automatically convert into a traditional loan after the certificate of occupancy on the house is received; one closing process and one closing cost amount. Many construction loans offer interest-only payments during the construction period. Some may offer terms including no payments during construction. This is handled by adding on the cost of the interest for the duration of the construction to the balance due on the loan. Since construction loans offer quite a lot of flexibility in terms, make sure you are familiar with what your banker is offering before choosing the correct construction loan terms for your situation.

 

A Home Improvement Loan is a loan secured to finance the cost of making improvements to your existing home, such as updating your kitchen, repairing a faulty roof or adding on a family room or a second level. The goal of any such improvement is typically to increase the overall value of your home, and the cost of the improvement should be weighed according to the value gained. In other words, when considering what upgrades to make, think about the current value of your home if you were to sell now. Add on the improvement and determine whether that would 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 important factor in making home improvements, but it is not the only variable. It is difficult to put a price on the extra enjoyment to be gained by you and your family for certain improvements made; a workout room,extra bathroom, playroom or kitchen upgrade could "pay for itself” in reduced stress levels or increased leisure time. Home improvement loans are typically shorter-term than home loans, but check with your banker as many banks offer flexible terms and attractive payment schedules.

 

A Home Equity Loan is based upon the current value of your home and the equity that you currently have in that home. Although it is secured by your home, the uses for this type of loan can be anything from financing college tuition, paying off medical bills or taking the vacation of a lifetime. The equity that you have in your home serves as security for the loan, which often results in interest rates and terms more favorable to the borrower than traditional consumer loans or credit cards. In many cases, the interest paid on a home equity loan is tax deductible. Home equity loans can be structured as traditional loans with fixed interest rates, 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, and the line of credit also typically has a variable interest rate and a set term and must be paid in full at the end of that term. Lines of credit often work exactly like a credit card as the homeowner uses the card to make purchases as needed. In either case, the home equity loan is only available during the time the home is owned by the borrower; once the home is sold the home equity loan becomes due.

 

Depending upon your goals and your current situation, securing some type of "home loan” may be beneficial. Whether your immediate future includes the purchase of your first home, adding on an extra bedroom or borrowing to help pay for college expenses, your banker can help you to understand the advantages to home loans now, and for your financial future.