Home Equity Loans

                A home equity loan is taken against the value of your home that is not already encumbered by a first mortgage.  Home owners take out home equity loans for a wide variety of reasons from vacations to remodeling.  As in all loans, it is good to have an idea of all your options before plunging into more debt.

                As you pay down the mortgage on your house, your equity increases.  The equity is the portion of the value of your home above the remaining loan amount.  So, say you have a home worth $300,000.  You have paid the first mortgage down to $200,000.  You now have $100,000 of equity.  A home equity loan uses that value-above-loan amount as collateral on a new loan, generally a second position. 

Home equity loans are different from refinancing, which pays off the first mortgage and usually gives the home owner some additional cash besides. Home equity loans are just a second loan.  Sometimes, the first has been paid off completely, in which case the home equity loan would be in the first position.

                Home equity loans can either be a lump sum amount or a line of credit.  The lump sum loans are similar to any other mortgage: the borrower receives the loan amount at closing.  Line of credit (Home Equity Line of Credit—HELOC) loans are taken over time.  The borrow draws against an amount determined by the lender.

                Home equity lenders will often loan up to 100% of the value of the house although some will only go as high as 80%.  The lump-sum second mortgage loans are generally given with terms of 15 years (with a balloon payment due at the end of that term) and a fixed interest rate.  Line of credit loans more often carry a variable interest rate, sometimes with terms as high as 30 years.  The line of credit allows the borrower to draw the money at amounts and times that they are ready for it.

Both home equity loans are commonly structured with a low payment, sometimes only covering the interest.  This may be a problem, however, when the balloon payment comes due. As with any other loan, the borrower needs to be aware of all the options before deciding on the best loan option. 

                Because the lender will be in a second position, credit requirements for a home equity loan are often more strict than with a first mortgage.  Your payment history, your income, your loan-to-value ratio, and your credit will all be taken in to account.  Also, there will be loan fees just as with a first mortgage.

                Home equity loans can be an excellent way to obtain additional cash for any number of needs that arise in your life from vacations to remodeling to education, but they also lower the equity in your home.  While this may seem like an easy road at first, that equity is a value that you have built up over the years.  On the other hand, many people build up that equity just so that they do have it for needs later on in life.  So before you encumber your home, weigh all the options to determine if a home equity loan is best for your current needs and your future financial stability.