How Does a Home Equilty Loan Work?
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Your home's equity is the difference between your home's current market value and the amount that you still owe on your mortgage. As your principal decreases, your equity increases. After you've been a homeowner for a while, you may have a desire to renovate the dream. A home equity loan grants you the opportunity to do that. Reason being, you do not have to wait until your home is paid off to get a return on your investment. You can borrow money from your home's equity now.
Types of Home Equity Loans
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Home equity loans are not just reserved for home renovations; they can be used for anything you want. There are two variations of a home equity loan. The first one being a lump-sum payment, which is paid directly to you. This option has a finite loan repayment schedule and a fixed interest rate. This type of home equity loan is also referred to as a second mortgage. The second type of home equity loan is a home equity line of credit, HELOC. This kind of loan has a variable interest rate, and the payments can fluctuate because the amount you owe on the loan--the interest will also fluctuate. You are able to draw money as needed by using a credit card provided by your lender or by using a special check. The loan schedule for both types of loans will usually vary between 10 to 15 years. Generally, the time allotted for repayment is based upon your FICO score and your credit history. The higher the score, the more time you'll be given to pay back the loan---and vice versa for a low score (see Resources).
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How Much Can You Borrow
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The amount you can borrow is typically no more than the amount of equity you have in your home. If you own your home or the mortgage balance is really low, it is ideal to borrow less than 80 percent of your home's value. If you exceed this amount, you will be required to pay for private mortgage insurance (see Resources).
Warning
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Homeowners tend to opt for a home equity loan because of the attractive interest rate. Also, the tax deduction makes the loan even more appealing. However, one of the reasons the interest rate is so low is because the loan is secured with your home. Meaning, if you default on a home equity loan, your lender can take your home away from you. A home equity loan is a way to get your hands on cash if you really need it, but be sure to shop around for the best deal, the best rate and the best lender before risking one of the biggest investments of your lifetime.
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