What are Home Equity Loans and How do they Work?
A Home Equity Loan (also referred to as Equity Loans or "HEL's") are a form of secured debt that uses your home as collateral for the loan, much like a standard mortgage loan does. Unlike a standard home loan however, a Home Equity Loan is based on the amount of EQUITY you have in the property as opposed to the total value of the property, and the proceeds of an Equity Loan are given to the borrower in cash. Home Equity Loans are commonly used by people that have owned their home for some time and now want to raise cash to pay for a special project such as renovations to their home, a wedding or college fee's for a child among other things. You can only get an Equity Loan if you own, of partly own your home, and the amount of your loan will be determined mainly by the difference between your home's current market value, and the total amount of any mortgages or debts secured against it.
Why use a Home Equity Loan?
Equity Loans provide people with an additional reserviour of cash that they would otherwise not have access to, by using their home as colateral on an Equity Loan you are able to get access to large sums of money at comparitively low interest rates, which means you do not have to draw on other, more expensive forms of credit such as credit cards, overdrafts or personal loans. Your Equity Loan will allow you to minimise the interest charges you incurr while still giving you access to the money you need instantly. In addition, you don't need to refinance your current loans, so there will be no "points" or early repayment penalties. |
|
Equity Explained
The Term "Equity" refers to the difference between the current value of the home, and the amount of debt that is attached to it. If your home is valued at $150,000 and you have a mortgage of $100,000 against it, then you have $50,000 of equity in the property. In general the amount of equity you have in your home will increase naturally over time as you pay down the debt with regular installments and the house appreciates in value. In some cases though your equity can decrease over time, as has happened with some homes in the recent past. Even if your home has dropped in value recently you probably have a significant amount of equity in the property if you've been paying the mortgage for a few years on an agressive repayment term such as 15 years, or you took the loan out over 5 years ago. the amount of Equity you have in your property determines the maximum amount of any Equity Loan you may want to apply for. |
Common Uses for Home Equity Loans
You can use the proceeds to a home equity loan for really anything you want, but there are some of the most common uses for an Equity Loan are:
- Paying for Renovations or Repairs to your home: This is an excellent use for an Equity Loan as it actually adds value to the property. If you need to make repairs to your home that are going to be expensive, or you want to make additions that will improve the value of your home when completed, a home equity loan is an ideal way to raise the funds needed to do so. You borrow against the current equity you have in the home, then use that money to incerease it's value, and therefore your equity again!
- Paying for a Special Project: This can be anything from buying a boat or new vehicle, to paying for a wedding or tuition fees on a college education. Because Interest rates on a home equity loan are lower than most other sorts of credit, it can be much more affordable to fund these expenses through an equity loan than using other forms of unsecured debt like a credit card.
- Starting a business: Getting funding from a bank to finance the start up costs of a new business can be very difficult, especially in the current risk-averse lending climate. Using an Equity Loan to finance a new business is often the best way of "boot strapping" (self funding) a new business venture.
- Debt Consolidation: If you have a lot of other debts that you are struggling with, a HEL can be a great way of getting those debts under control. Think of it as an automatic debt repayment system. You take out a HEL for the total amount of the other debts you have, and use it to pay those debts in full. Now instead of paying off three or four different loans, you are just making repayments on one loan, structured over a set term (probably 5-10 years) and at a lower interest rate. As a result you can get your debts under control, as well as reducing your interest bill and monthly repayments, and you build up your credit score to boot. Using an Equity loan to settle other high interest debts is one of the smartest financial moves you can make in many cases.
What are the down sides of a HEL?
The biggest disadvantage with an Equity Loan is that the amount you borrow is limited by the equity you currently have. this can mean that you are unable to borrow as much as you would like to, and possibly not enough to fully cover the costs of your project. Other disadvantages include a higher interest rate than a standard mortgage loan, and the fact that you have to take all of the money up front rather than dripping it out over time.
Despite these drawbacks, a Home Equity Loan remains the preferred method of capital generation for many people throughout the USA.
