Home Equity Loans

    
An equity loan is a mortgage placed on real estate in exchange for cash to the borrower. For example, if a person owns a home worth $100,000, but does not currently have a lien on it, they may take an equity loan at 80% loan to value (LTV) or $80,000 in cash in exchange for a lien on title placed by the lender of the equity loan.

Many lending institutions require the borrower to repay only an interest component of the loan each month (calculated daily, and compounded to the loan once each month). The borrower can apply any surplus funds to the outstanding loan principal at any time, reducing the amount of interest calculated from that day onwards. Some loan products also allow the possibility to redraw cash up to the original LTV, potentially perpetuating the life of the loan beyond the original loan term.

Home Equity Loans have become increasingly common starting from mid-1980. It was the time when property values appreciated considerably. Home equity loans, with their attendant benefits of attractive interest rates and tax deductibility, provided a great avenue to people who knew how to manage their personal debt . Home equity loans were originally designed to finance home improvements. That makes sense because improvements add equity value to your home, which increases the collateral value for the loan. If you run into financial difficulties that force you to sell the home, the increased market value would hopefully cover the additional debt.

The rate of interest applied to equity loans is much lower than that applied to unsecured loans, such as credit card debt.

1. Home Equity Loan - A home equity loan is a loan that uses your home as collateral. Your home equity is the part of your home that you actually own and this is the guarantee for your loan. A house equity loan, often called a second mortgage, reduces your equity or ownership in your home. Since your home guarantees your loan, if you default on the payments, you can lose your home. A home equity loan can be used for anything from paying off high-interest credit card debt, to home improvements to buying a car. The best uses of a home equity loan improve your financial situation, your home or your future and these include debt consolidation, home improvement and education.

There are two basic types of home equity loans: the criterion home equity loan and a home equity line of credit.

1. The Standard Home Equity Loan -

A standard home equity loan, (also called a term loan, a closed-end loan or a second mortgage installment loan), works like a traditional loan. You receive a lump sum payment at a fixed interest rate and you pay the money back in monthly payments over the life of the loan. Since the interest rate on the loan is fixed, your monthly payments will also be fixed.

2. Home Equity Line of Credit -

A home equity line of credit works like any other line of credit. You are granted an amount you can borrow and you draw money from the account as you need it. You pay interest on only the amount actually borrowed and the interest rate is variable over the life of the loan. While most home equity lines of credit have a variable interest rate, a fixed interest rate can sometimes be negotiated. A home equity line of credit is 'revolving' meaning that you can borrow money, pay off the borrowed money and then re-borrow that money. The money in a home equity line of credit is accessed using specially issued checks or credit cards

Advantages and disadvantages of a home equity loan -

A lower interest rate and tax deductions are the two major advantages home equity loans have over other types of debt.

The biggest drawback of a home equity loan is the fact that your home is on the line and you could lose your home if you default on your payments. When you borrow from your home's equity you also reduce the equity or ownership you have in your home. This means that you trade ownership or equity in your home for cash that you will use for some other purpose.

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