Home equity loans

Many homeowners acquire home equity loans in order to finance some of their needs such as home improvement, vacations, and even emergency expenses. But what exactly is a home equity loan and how is it similar or different from the mortgage loan. In one aspect, the home mortgage loan and the home equity loan are the same because both are secured loans. That is, the loan is secured with the home as collateral. The collateral is the borrower’s guarantee to the lender that he or she is motivated to pay off the loan. Otherwise, the collateral will be owned by the lender. If the collateral is the home, the usual recourse of the lender is to sell the home and the homeowner is evicted. With this in mind, a borrower must be prudent before taking a home equity loan and risking the loss of his home.

From other aspects, the home equity loan is different from the home mortgage loan because of the loan term, the interest rates, and the amount that can be borrowed. The loan term of mortgage loans is usually longer than home equity loans. The term of a mortgage loan can be as long as 30 years while the term of the home equity loan is between 5 to 15 years. Since the home equity loan is considered a second loan secured on the house, the interest rate is higher than that of the mortgage loan. And finally, the amount that can be loaned will differ between the mortgage loan and the home equity loan.

In the mortgage loan, the amount loaned is the value of the house being bought. This loaned amount can be reduced by the down payment made on the house. For example, the value of the house can be $150,000 and the down payment made is $20,000. This means that the mortgage loan is equivalent to the difference between the down payment and the value of the house, $130,000. The home equity loan, on the other hand, will be equal to the difference between the value of the house and the amount that the owner owed in mortgage. Thus, on the day the house is bought, the equity is roughly equivalent to the down payment.

As years pass, the value of the house will appreciate and it may now be equivalent to $250,000. At the same time, the homeowner may have faithfully paid the monthly mortgage bills and has reduced the principal mortgage loan by $25,000. This means that the remaining mortgage loan is only $105,000. The difference between the mortgage balance and the present value of the house ($250,000 - $105,000) is the equity of the house ($145,000). The homeowner can get a home equity loan for as much as this amount.

 Home equity loans pros and cons

For people who needed money for long-term projects, the home equity loan can be a good strategy. The interest rates of home equity loans are relatively lower than personal loans. However, the borrower must remember that once a home equity loan is taken out, no more additional loans that are secured to the house are allowed. For borrowers who intend to change jobs with the possibility of earning less, the home equity loan is not the best solution because the borrower’s risk of losing the home is high. It is also not recommended to get a home equity loan when the value of the house is decreasing, the real estate market is slow, and when the homeowner plans to sell the home. Similar to all loans, a home equity loan must be considered seriously and the borrower must first weigh the pros and cons before applying for this type of loan.

How home equity loans work

The home equity loan can be released as one lump-sum or as a line of credit. If the former method is chosen by the homeowner, the cash, which is equivalent to loaned amount minus the fees and interest, will be immediately received. If the latter method is chosen, which is also called the HELOC (Home Equity Line of Credit), the borrower is given a credit card with a credit limit equivalent to the home equity. Some lenders require the borrowers to take a cash advance from this credit card upon approval of the loan.