How does a home equity loan work?

New home owners are often wondering about certain loans that their banks are trying to offer them. A home equity loan is probably one of the most common and most often asked about. To sum it up in a few words, a home equity loan is basically using your home as collateral in order to get a loan which is often in the amount of a large sum of money. People generally take out home equity loans to finance major expenses that they just can’t afford at the moment. The most common thing people use these for is home repairs usually to update and remodel outdated bathrooms and kitchens. They are also commonly used to pay for medical bills or college tuition. The home equity loan puts a lien against the borrower’s property. In the case of one selling their home, this lien will have to be paid off first out of the money made from the sale of one’s home.

In order to get a home equity line of credit the borrower will have to have an excellent credit score. The home also has to have a reasonable loan to value ratio in order to even be considered for the loan. For example, if your first mortgage is for $100,000 but your home has been appraised or assessed at $225,000 you have a great deal of equity available in your home. Home equity loans are almost always for a shorter term than the original or first mortgage. The loans are given in one lump sum and will often have a fixed interest rate which will always depend on the ever-changing market. Your bank will have all of these rates for you when you go and apply.

It is always best to shop around for the best terms and rates for your home equity loan. Don’t just think that you have to go to the bank that you normally do your business with. Take some time to go and talk with a home equity specialist at a few banks to see what is the best deal that will work for you. A little research will only help you in the long run.

Home equity loans are a type of loan most borrowers look at when they have large, predictable expenses coming up. Very common uses are to pay for college tuition or to make large home improvements. Some important notes on home equity loans:

1. Higher interest rates - Most equity loans will have a higher interest rate than a first mortgage. For most borrowers, they will have to figure out whether it would make more sense to use a home equity loan or whether they should refinance their first mortgage. Like any type of loan, there may be closing costs equal to a percentage of the total loan, along with other fees and charges. Home equity loans are available at adjustable or fixed rates.
2. Equity– to figure out how much of a loan you can get you need to know how much equity you have in your home. By taking the market value of the home, and subtracting the loan you have against it you can figure out how much equity you have.  Take that figure and multiply it by 60%-80%, depending on your credit, with a higher score letting you take a higher percentage. Your final result will be the typical amount you could borrow from most lenders.
3. Lump Sum – home equity loans are dispersed in a single lump sum. This is great for large, planned expenses; however, if you’re expenses are unpredictable a home equity line of credit (HELOC) may be a better fit.
4. Secured by home – a home equity loan requires you have equity in your home. To secure the loan, you have to put up your home as collateral against the loan. As is the case with a regular mortgage, failing to make on time payments on a home equity loan can cause a home to be foreclosed on.