Considering financing your pool?
A quick overview of home equity-based loans
The three most common home equity-based loans
Swimming pool projects can get costly quickly. If you’re a homeowner curious about the basics of financing your pool project using the equity in your home, we wrote this article for you. The most common types of equity-based loans are called: Home Equity Loan, Home Equity Line of Credit, and Cash-Out Refinance. We’ve included a simple definition for each type of loan, along with some associated risks. We hope you will gain enough information to decide if a home equity-based loan is an option you want to pursue, and if so, when you speak to a lender or broker, you will have a basic understanding of what each type of loan entails.
Working with a pool contractor
Many pool contractors collaborate with companies that help homeowners secure loans for their pool projects. These loans are often based on the equity of your home even if they are referred to as a “pool loan”. If you go this route, it is likely you will be working with a mortgage loan originator (MLO) or a broker who assists borrowers find and apply for a loan.
About MLOs and Brokers
MLOs are licensed individuals who work for a financing institution such as a bank, credit union, mortgage company and broker. Mortgage brokers work independently, as individuals or businesses, and partner with multiple lenders. It’s important to know that while both MLOs and brokers help you secure a loan, neither issues the money to finance your loan. MLOs and mortgage brokers are licensed through the Nationwide Mortgage Licensing System (NMLS). You should be able to verify the license of any MLO or mortgage broker you are thinking about working with. For more information, visit:
First, a little bit about equity
Equity-based loans
All equity-based loans tend to offer lower interest rates compared to unsecured personal loans. Even though you use your home’s collateral to secure a home equity-based loan, your approval, interest rates, and terms are based on your credit score and debt-to-income ratio, in other words, the same criteria used for a new mortgage. Be prepared for a credit check. A credit score of 700 or higher will get you the best rates. If your credit score is below 620, loan acceptance and good rates will probably be difficult. You can expect to provide the following paperwork to show: official identification like a driver’s license; proof of income with documentation like pay stubs and tax returns; proof of home owner’s insurance; your recent mortgage statement showing your current mortgage balance; and bank statements (usually at least two months’ worth). No matter the type of loan you decide to pursue, you will want to get multiple estimates from local banks, credit unions, and reputable online lenders. If you use an online lender, make sure the broker is licensed with the Nationwide Mortgage Licensing System (NMLS).
Calculating equity
The amount you can finance is based on the amount of equity in your home. A fast way to determine your home’s equity is to subtract what you currently owe on your home mortgage from your home’s value. For example, if your house is worth $550,000 and you owe $375,000, your current equity is $175,000. Websites like Zillow, Redfin, and Realtor.com use algorithms that factor in recent sales and property features, among other variables to give you a quick, estimated home value. However, your lender may arrange for a professional appraisal to do a more thorough assessment of your home’s value. In general, your loan amount will not exceed 85-90% of the value of your equity. Using the example above, you could potentially borrow up to $148,750-$157,500.
The Home Equity Loan
A home equity loan is actually a second mortgage. In essence you are borrowing against the equity of your home to obtain a new, separate mortgage. Home equity loans typically feature fixed interest rates and fixed, predictable monthly payments. You receive your loan amount in one lump sum (unlike a Home Equity Line of Credit). Additionally, the range in the length of terms offered can vary from 5 to 30 years.The longer the terms, the lower your monthly payments. Other potential advantages of a home equity loan include possible tax benefits and an increase in home value. Both of these are dependent on your specific circumstances. For example, if your pool project is considered a “capital improvement” to your home, your interest could be tax-deductible.. Additionally, in some areas, a pool can improve your home’s resale value. By areas, we mean high-value markets and locales with warmer climates.
Home Equity Loan Risks
Foreclosure, equity reduction, and the long-term commitment are the most obvious risks with a home equity loan. If you default on your loan, your home is at risk of being foreclosed upon. While taking out a loan to invest in your home to potentially increase its overall value, if your home’s value decreases after you take the loan out, you will have reduced your equity, and you could end up owing more than your home is worth. Even though a home equity loan typically comes with consistent payment amounts, you are still making what could be a long term commitment to pay back the loan.
The Home Equity Line of Credit
A home equity line of credit (HELOC) is a revolving credit line secured by the equity in your home. It’s similar to a credit card except that it’s backed by your home’s collateral. A HELOC has a draw period and a repayment period. The draw period typically lasts 5-10 years while the repayment period can last between 10-20 years. You can borrow at any time during the draw period and then you pay it off during the repayment period. Often, you can make interest-only payments during the draw period which lowers your overall payment costs. Interest rates are usually variable, but fixed-rate options can be available. One benefit of a home equity line of credit is that you can borrow what you need as your project progresses, rather than estimating the amount you’ll need, like you have to with a home equity loan or cash-out refinance.. Depending on your specific circumstances, your HELOC interest could be a tax-deduction if your pool project is considered a home improvement.
HELOC Risks
Managing payments with a variable-rate loan requires some forethought, especially since missed payments can lead to a foreclosure on your house. Another risk with a HELOC is borrowing more than you need. It can be tempting to pay for things you had not initially intended when you have access to such a substantial amount of cash in your line of credit, knowing you won’t have to pay it back for several years. This can lead to accumulating more debt than you mean to, while also losing equity in your home, which could be, like for most Americans, your largest asset. If you think having easy access to so much cash will lead to impulsive spending, consider an alternative option, that way you can be sure to curtail your home equity-related debt and maintain a higher level of equity in your home.
Cash-Out Refinance
A cash-out refinance is the process of refinancing your initial mortgage, essentially replacing your existing loan with a new, larger loan. The difference between your new loan and former mortgage is what you receive in cash. For example, if your house is valued at $550,000 and you owe $375,000 on your original mortgage, and your pool will cost $75,000, you could refinance a new loan for $450,000, to receive the funds to build your pool.
Cash-Out Refinance Risks and Drawbacks
When you opt for a cash-out refinance, you will be refinancing at current market rates, and your new mortgage will completely replace your old one. Depending on your terms, this may prolong your timeline for paying off your loan. A drawback of a cash-out refinance is that you pay closing costs (typically 2-5% of the loan amount). Similar to a home equity loan and a HELOC, missed payments can lead to foreclosure. Additionally, keep in mind that whatever you borrow, you will lose in equity. If your home loses value for whatever reason, such as a market fluctuation, you could end up owing more than your home is worth. However, given the risks and drawbacks, if you plan to stay in your home long enough to recoup your closing costs and current interest rates are more favorable than when you initially bought your home, a cash-out refinance could be a good option.