Home Equity Loan

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Home Equity Loan

Home LoanHome equity loans are a useful tool for many home buyers. Home equity loans are also called line of credit mortgages. You will see the terms used interchangeably by many lenders.

Home equity loans have a myriad of uses and can be used very effectively to repay a loan very fast. Depending on their structure and lender they can be used as an effective overdraft or have a reducing balance. In this article we’ll look at the features of a home equity loan and discuss the benefits and drawbacks.

What are they and how do they work

A home equity loan at its essence is one where you have more than 20% equity in your property. If you have less than 20% equity in your property there is little to no chance of obtaining a home equity loan. As an example, if you have a property worth $500,000 you will need to have less than $400,000 worth of lending to qualify for a home equity loan. So if for example you have $350,000 worth of lending you may qualify for a home equity loan of $50,000.

A home equity loan is essentially a revolving line of credit secured on your property. They are used in many different ways – we’ll discuss this during the article.

There is nothing stopping you from having a home equity loan as part of a loan package and it may only make up a small proportion of your lending portfolio. Many borrowers have a home equity loan as part of their portfolio, this is a very common lending position.

Your ability to borrow will be assessed as normal and you’ll need to demonstrate the ability to repay the loan. Your lender will take you through the process, but if you’ve been through this process before you should find little reason for the process to be different.As with all credit applications your credit history will be checked, and assuming you’ve been repaying your current home loan on time as agreed there should be little difference and few reasons why you should not obtain finance. If you are taking out a revolving line of credit on a property you own outright then you’ll need to provide that property as security for the loan.

Your home equity loan will be structured in one of two different ways. Either it will be a revolving line of credit where the limit is set and you cannot go above. Alternatively your lender might suggest a reducing balance home equity loan which means your lending limit slowly reduces each month allowing you to build some equity in your property as each month goes by. The line of credit means your loan is essentially an interest only loan with no limit reductions meaning you’ll never actually develop any equity in your property., unless you pay down your loan.

 

Benefits

A home equity loan is a really good loan if you want to be able to smash large portions of your loan off with no penalty. Essentially you can pay as much off your loan as your choose at any point in time. There is no limit to your repayment ability. This is great as you only pay interest on the balance outstanding. These loans are completely flexible.

Many people use these loans to reduce the outstanding balance during the month by having their salaries credited directly in to the account thus reducing its balance. They then pay all bills by credit card and pay that balance off each month maximising the effect of the reduced balance on the interest charged on the home equity loan.

There is no control on what you can use the funds for. Many borrowers use the funds to purchase another property, buy shares, a car, boat, the options are almost limitless. The benefit is that you only pay mortgage interest rates on the loan as opposed to higher car loan, margin loan rates etc.

Many lenders will allow you to have a number of accounts within your home equity loan allowing you to allocate funds from different accounts to different projects. An example might be one account for a home renovation, the second might be for a purchase of a second property. This is good from a tax and accounting point of view allowing interest allocation as appropriate.

These loans can be used almost indefinitely allowing funds “recycled” to be used to purchase further items whether it is another car, pay of other debt or buy another property. If for example you buy a property with the intention of renting it out all rental receipt can be placed into the account reducing the outstanding balance of the loan.

 

Negatives

Home equity loans are adult finance. They really are not for the use of first time borrowers who have little to no experience of lending. Home equity loans – especially ones which do not have reducing limit can trap unwary people not used to having to keep loans within particular limits and can mean you never actually gain any further equity in your own property.

If for example you buy a car with the proceeds of a home equity loan you need to be aware that potentially you are going to take a lot longer to pay off the loan than what you might with a standard car loan over say 5 years. Home equity loans are written over a period of 25 – 30 years and as such you could end up paying a lot more interest should you proceed down that route. If using a loan such as a home equity product for purchasing a car you are wise to consider paying off the loan at the same amount as you would have been paying off a car loan. Not only will you pay less interest you’ll own it outright faster.

Home equity lending is a great option for many borrowers the flexibility gives these types of loan unrivalled capacity for developing financial options. When use correctly they allow you to unlock equity in your primary property to allow greater purchases of other consumer goods, renovations (to improve the value of your property) even allow you to buy another property.

There are no other loans on the market that allow you to access funds in this manner. One area you need to consider is whether your home equity loan is interest only (i.e. no principal paid down) or one where the lending limit is slowly decreased month by month. The choice of product is key to understanding your own personal situation.

Home equity loans are a common source of funding for many people and are increasingly sought by borrowers. They are a great source of finance but must be used wisely to ensure you gain the best value from the financial product purchased.