What are Home Equity Loans?
A home equity loan, often called a second mortgage, is a loan that uses your house as security, or collateral. This type of loan guarantees the lender that you will repay the obligation because they can pursue foreclosure if you default severely on your payments. Home equity is determined by deducting what you owe from what your house is worth.
Advantages
While the interest rate on a home equity loan is lower than that of a credit card or unsecured personal loan, it is higher than that of a standard mortgage because the lender is second in line should the home be sold or foreclosed on by the primary lender. However, you'll find the interest rates on home equity loans tend to be quite favorable, because the investment requires less risk on the part of the lender. Another advantage is that regardless of how you use the money, the interest on the loan you pay on the first $100,000 borrowed is tax deductible ($1,000,000 if the money is used for home improvements or to purchase an additional home).
This means that if you pay $4,000 in interest on your equity loan, you can reduce your taxable income by $4,000 when doing your taxes. Credit cards and other unsecured loans don't carry this advantage, which an equity loan gives. You will certainly want to consult a tax advisor to be certain about any appropriate tax benefits.
The biggest drawback is that if you can't keep up with the payments, your home may face foreclosure.
In addition, when you decrease your home's equity value, you also reduce the ownership you have in your property. Finally, aside from the interest you will pay on the home equity loan, there are also some costs associated with taking out a home equity loan that are similar to when you took out your first mortgage.
Financing Options
There are two different kinds of financing, a home equity loan and a home equity line of credit. A home equity loan resembles a term loan in the sense that it works like a traditional cash loan. You will receive a lump sum payment as your home equity loan and pay a fixed interest rate on the funds.
Depending on the terms of your home equity loan you'll pay a fixed monthly payment until the loan is paid in full. As an example, a $30,000 home equity loan at 7.5% will require 10 years of monthly payments equal to $356.11. In this scenario, you are granted an amount that you are allowed to borrow but you only have to take what you need when you need it. If you don't borrow it, you won't owe any interest on it.
For example, if you are given a $20,000 home equity line of credit and you only use $10,000 of it, you'll only pay interest on the $10,000 you borrowed. As the principal is paid back, your available funds will increase accordingly.
Home Equity Loans and Lenders
Typically, lenders will allow to borrowing up to 80% of your equity. So, if you have $50,000 in equity then you would be allowed to borrow up to $40,000. There are other programs that allow you borrow up to and even over your equity value but you may need stronger credit and endure higher fees in this scenario. Essentially, the greater the risk to the lender, the higher your interest rate may become.
If you are interested in obtaining a home equity loan for any reason, we invite you to visit our pre-screened corps of home equity lenders ready to assist you.
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