A home equity loan is basically a second mortgage that uses the available equity in the borrower's home as collateral for the loan. This type of loan creates a lien against the home and is considered a secured loan and will effectively reduce the equity in the home. Home equity loans provide a way to quickly get cash for a variety of needs.
Types
There are two types of home equity loans. A closed-end loan is similar to traditional mortgages in that the borrower makes fixed scheduled payments with interest. The date for final repayment is set and once met, the loan is closed. An open-end home equity loan, also referred to as a home equity line of credit, is a revolving credit account that remains open constantly. The borrower takes out as little or as much as needed. The monthly payments then vary, based upon how much is borrowed or paid back, over time.
Uses
While funds from a home equity loan can be used to finance anything, they are often used to finance big ticket items. These include educational expenses, such as sending one's children to college, home improvements or medical bills. The funds from a home equity loan can also be used for debt consolidation, such as moving high-interest credit card debt to low-interest home equity debt.
Determination of Eligibility
Most home equity loans require an excellent credit history. The borrower will be approved for a specific amount, based on the available equity of the home. The amount is often determined on a percentage of the appraised value of the home, minus the balance owed on the current mortgage. The borrower's ability to pay will also be factored into the amount to be lent.
Interest Rates, Terms and Payments
Home equity loans usually have a fixed interest rate determined by the lender and based on prevailing rates. While most traditional mortgages are paid over 30 years, home equity loan terms may be as short as five or as long as 30 years, although 15 years is average. Home equity loans are paid out as a lump sum and home equity lines of credit are paid out as needed from an active account.
Benefits
Because they are a secured loan, home equity loans carry a lower interest rate than credit cards or consumer loans. Also, the interest paid toward a home equity loan is tax deductible up to $100,000 or the equity value of the home. Home equity loans are also flexible, allowing the borrower to determine when and how to use the money he borrows.
Risks
Shop around for the best deal on a home equity loan. There are many unscrupulous lenders in the market that use hidden and expensive fees, unreasonable terms, high interest rates and other predatory practices when originating loans. Also, because the borrower is putting up the equity in the home as collateral, the lender has a stake in that property. If the borrower defaults, the lender may have legal recourse to take possession of the property.
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