Home Equity Loans

Ever since the second half of the 1990’s, the home equity loans have enjoyed great popularity. This can be explained with the fact that they are more affordable and easier to get compared to the traditional consumer loans. However, this does not mean that there are not any traps. It is worth looking into these loans in greater detail so that you can decide on their usefulness given your individual needs and circumstances.

Home Equity Loans Explained

These loans are secured with the equity which you have in your home. This is where their name comes from. The idea is that you borrow money against your home equity. Its size will affect the loan amount. Usually, you can borrow quite a lot of money even if you have a mortgage already. If you default on the loan, the lender will have the right to take your property and sell it in order to recover their losses.

It is important to note that if you have a mortgage and you default on this type of loan, the mortgage will be repaid first. This makes home equity loans, which are often referred to as second mortgages, riskier for lenders. As a result, they are more expensive than the so called senior mortgages.

The amount of money that you can borrow depends on the size of the equity that you own in your property, on the loan to value ratio and on your credit score. The maximum amount of money which lenders grant corresponds to 85 per cent of the value of your home minus the amount on your first mortgage which is still due. You can readily use a specially designed calculator to figure out how much you can borrow.

Types

There are two types of home equity loans that you should look into:

Fixed rate loan – With this loan, you get a lump sum when you take out the loan. The interest rate is fixed throughout its term. This means that the monthly payment has a fixed size as well.

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Loan Type

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Home equity line of credit (HELOC) – This loan works much like a credit card and comes with a variable interest rate. You are approved for a certain loan amount. You can withdraw cash at any time up to the set limit. The monthly payments depend on the amount of money that you have taken out and on the interest which varies as per the terms and conditions of the loan. The line of credit has a fixed term just like its traditional counterpart. When this term is reached any outstanding debt must be paid in full.

Cost

The interest rates on home equity loans are higher than the 30 year mortgage rates, for instance. At the same time, they are lower compared to those on unsecured loans. Usually, the so called second mortgages have considerable closing costs which can reach 6 per cent of the total loan amount. Most lenders charge participation fees as well. If you use a line of credit, you may be charged a fee when you take out money. Penalty fees for early repayment may apply as well. It is best for you to use a home loan calculator to figure out how much a loan of this type will cost you.

Uses

Home equity loans are typically used for making further investment in the property owned or for purchasing a major asset. Most people take out such loans in order to finance repairs or to invest in energy-efficient solutions for the home which will lower their bills in the long term. The funds can be used for the purchase of a car or another valuable asset. In some cases, families used the money to finance the education of their children. Second mortgages can be used instead of small business loans and unsecured short term loans.

Benefits and Risks

The main benefit of home equity loans is that they are easier to get than most consumer loans even if you have a low credit score and bad credit. They are also cheaper than the majority of consumer loans. At the same time, there is always the risk of losing your home if you default on the repayment and get into trouble with the home loan services.

Overall, home equity loans are useful and quite beneficial but they should be approached with caution.

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