What is a Home Equity Loan?

Published by Thomas Herold in Banking, Real Estate

'Home Equity Loan' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A home equity loan is a means for home owners to borrow money using the value of their house. Borrowers find these loans appealing because they can usually borrow significant sums of money. Besides this, they are much simpler to get approved for than with many competing kinds of loans. A home owner’s house secures these home equity loans. The borrowers may utilize these funds for any purpose that they wish. They do not have to be spent on expenses related to the house that secures the loan.

Such a home equity loan is actually a kind of second mortgage on a house. The first mortgage allows the buyer to purchase the home. When sufficient equity is established in the house, owners can attach other loans to the property to borrow against it.

There are a number of benefits to obtaining a home equity loan. They appeal to both lenders and borrowers. Borrowers get better APRs or interest rates from them than with other loan types. Because they are secured by the value of the home, they can be easier to get approved for even with bad credit. The IRS allows home owners to deduct interest expenses from these home equity loans from their taxes. Finally, borrowers are able to obtain substantial loan amounts using these loan vehicles.

The lenders like these loans because they consider them to be safer loans. The house acts as collateral in the process. This means that banks are able to seize the house to liquidate it and regain unpaid balances if the owner fails to make the payments. Because of this, banks know that borrowers will make the payments of these loans a high priority so they do not lose their house.

Banks protect themselves in any case by not lending too much against the value of the property. In general, lenders will not allow borrowers to obtain a greater amount than 85% of the value of the house. This includes both the amount that remains on the first mortgage as well as the second mortgage home equity loan. This percentage is known as the loan to value ratio. It can vary somewhat from one bank to the next.

The way home equity loans work is relatively straightforward. Borrowers receive a one time cash payment. They then make fixed payments each month to pay back the loan over a pre-set amount of time. The interest rate will be set by the bank at the beginning of the loan. With every payment, the loan balance declines after part of the interest costs are covered. This makes these amortizing loans.

Sometimes borrowers do not require all of the money at one time. An alternative to the home equity loan in this case is the HELOC home equity line of credit. This delivers a set amount of money which home owners can draw on only when and if they require it. The borrowers only have to pay interest on money which they physically draw and borrow. It is possible for the interest rate to change on these HELOC loans. Banks may also cancel such a line of credit before the borrower has utilized all or part of the funds.

Home equity loans can be used for many different needs. It is wise to improve the value of the house with the money through renovating, remodeling, or increasing the appeal of the property. Other common uses borrowers employ them for are to help pay for a second home, to afford college tuition and expenses for family members, or to consolidate bills with high interest rates.

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The term 'Home Equity Loan' is included in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.