Home Equity for Loans

Home equity can be used by home owners to secure loans. This becomes possible by using this home equity as collateral against which banks and other financial institutions would lend money. As collateral the home equity serves as a guarantee that the money taken as debt will be repaid. Failure to repay would mean that the lender can sell the home to recover his loan. Hence the home is at stake when it is used as equity. Equity can be calculated as the difference between the actual value of the home and the mortgage amount. The loan actually reduces the actual home equity and a lien gets created against the property belonging to the borrower.

A home equity loan is actually a second mortgage taken by many property investors. This enables them to convert equity into cash that can be spent on repairs and renovations, consolidating debt, upgrading or even meeting non property related expenses. These however, have to be repaid in a shorter period of time than a first mortgage. The loan is a lump sum amount that is provided, with a fixed rate of interest and fixed payment installments every month till it is paid off completely. If the loan is used for renovation and upgrading of property, it actually helps to add value to it. However, all renovations and improvements may not enhance the value of the property and the home equity loan may be a burden that does not yield returns.

Home equity loans differ from home equity line-of-credit, which gets borrowers a credit line that can be used to draw funds as and when the need arises, unlike the loan which is a one-time lump sum payment. A line of credit also comes at a variable rate of interest, which leads to uncertainty over payments and higher costs should the interest rates increase.

Benefits of home equity loans

  • Lower interest rates- most home equity loans come with a lower rate of interest than other debt instruments.
  • Provides tax benefits since the interest paid on these loans can be deducted before calculating taxes.
  • Can be used for debt consolidation- this helps to combine multiple debts taken into a single large loan that is easier to manage, may be at a lower fixed interest rate and will then help to spend in a more disciplined manner.
  • Additional principal payments can be made to reduce the debt burden. However, all financial companies may not offer this feature.

Home equity loans can be shopped for in the same manner as other financial instruments to get the best rates, flexible payment plans without penalty and other benefits. A good credit score helps borrowers. Home equity loans can be taken for amounts equivalent to nearly eighty percent of the property value, and hence place a big amount of money at the borrower’s disposal. However, it does mean placing a home property at stake, and there are risks involved since the property will be taken away in case there is a default.

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