What is a Home Equity Loan?
A home equity loan is an example of a secured loan – the money is loaned to you with the value or equity in your home as security. Put simply, the equity is the difference between the amount you owe on your mortgage and the amount your home is actually worth at current market value.
For example if your mortgage is for $150,000 and your home would now sell for $200,000 you may be eligible to take a loan out for the additional amount of $50,000. The remaining value of your home is security on the loan.
Home equity loans, sometimes called a second mortgage, are more popular with homeowners than ever – in 2005 an estimated $204 billion was cashed out in home equity in the United States.
Advantages
There can be significant tax advantages of taking out this type of loan. Always consult with your tax advisor, but the interest paid on the loan may be tax-deductible. Most of the closing costs and fees for a home equity loan are paid up front or can be rolled over into the loan itself. Interest rates on these loans tend to be competitive.
With many plans you can pay off the loan sooner, by paying more towards the principal, rather than just paying the minimum payment – just as you can with your mortgage payments. And the cash from your loan can generally be used for whatever you like – home improvements, vacations or college tuition costs are all popular reasons for taking out a home equity loan.
Disadvantages
Just as with your actual mortgage, you run the risk of losing your home if you don’t make the payments on a home equity loan. If the value of your home drops significantly, you may end up owing more on the home than it is actually worth. A home equity loan may not be the right choice if you are contemplating a career change and potentially a lower income.
There are also various charges and fees usually associated with taking out the loan, which can rapidly add up although often the charges can be incorporated into the loan amount. The charges typically include a property application fee, home appraisal fee, title fee, taxes and points on your mortgage.
Things to Watch Out for when Applying for a Loan
Some loans have steep penalties for paying off the loan too early – a typical penalty might be 10% of the amount borrowed. Make sure there isn’t a penalty assessed by the lender for prepaying your home equity loan. Be careful of loans in which you are just paying the interest each month and are then hit with a large payment of the principal amount towards the end of the loan term. These are sometimes known as balloon loans.
Don’t forget the “three day” rule – you have the legal right to cancel your loan within three days of taking the loan out, in which case all the application fees will be returned to you.
Finally, one thing you may want to do is consider a home equity line of credit rather than an actual loan – this has the advantage that you are only paying interest on the amount you actually use. You may have a potential line of credit of $20,000 but only actually use $5,000 of it – you are only paying interest on the $5,000.
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About The Author
John Mussi is the founder of UK Personal Secured Loans who help homeowners find the best available loans via the http://www.uk-personal-secured-loans.com website.
