How home equity loans work
Simply put, home equity loans are those loans that are issued against the equity of your home as the collateral.
Equity is the difference between the present price of the home you own and the amount you owe as the loan on it. For example, if you buy a house worth $300,000 by making a down payment of $30,000 and the remaining $270,000 as loan, your equity on the day of buying will be $30,000, which is equal to the down payment you make. Now, say after 5 years, assuming that you make regular payments, you would have paid close to $20,000 which will mean that you owe $270,000 - $20,000 =$ 250,000. At the same time, the value of your home would've gone up to about $380,000.
Therefore your equity after five years on your home will be $380,000 - $250,000 = $130,000. In other words, a 2nd mortgage is a home equity loan where you effectively turn the equity on your home into cash which could be used for other purposes like the maintenance and improvement of your home, any previous debt repayment, towards educational expenses etc.
Collateral is the property which you pledge as a guarantee for your willingness to repay the loan. The creditor may compensate for your failure, if any, in repaying the loan by seizing the collateral.
Types of home equity loans:
There are mainly two types of home equity debts available in the market. They are regular home equity loans which are also known as closed end home equity loans, and Helocs or the home equity line of credit. As they are guaranteed by your property, both of them are also at times referred to as second mortgages. Both home equity loans and Helocs have to be repaid in a shorter duration than primary mortgages. Generally, repayment period of mortgages is over 30 years, while home equity loans and Helocs will have a life of 15 years and still shorter as well.
Helocs are more flexible than regular home equity loans which have a constant rate of interest. In the case of normal home equity loans, the borrower receives the money in one go, the amount of which will be dependent upon the facts like his/her income, credit history and the value of the collateral he possess. Also, with home equity loans, the debt may still remain as you pay down the interest rather than the principal.
Home equity lines of credits or Helocs, which are also called open end home equity loans, allows you to borrow a preset amount for the full period of the loan, the duration of which is fixed by the lender, during which time, you withdraw money as per your needs. You can use the credit again as you make payments towards the principal amount, similar to using a credit card.
To avail a home equity loan:
Before you decide up on your home equity loans provider, you should do a primary comparison of the different offers that are put forward by home equity loan lenders in your area. You should be certain about the fact that you end up with a home equity loan that fulfills your particular needs. You will have to pay certain fees for the application, attorney, property insurance; taxes etc. home equity loans also carry annual fees for maintenance and memberships.
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