Want to Know What A Home Equity Loan is and How it Works?
Home equity, sometimes known as real property value, is defined as the difference between a home’s market value and the outstanding mortgage to be paid on said home. The property’s equity will increase as the owner pays off the mortgage or the market value of the property rises.
A home equity loan, therefore, is a type of home loan in which the borrower may use the equity of their home as collateral. Meaning that the bank, credit union or other financial institution that provides the loan will be able to claim this equity if the terms of the loan are not adhered to.
Home equity loans are typically sought by those who are faced by large expenses such as home repairs, medical bills or college education.
For those who qualify for a home equity loan – something that will normally require a solid credit history – there are two main types from which to choose. There is closed end, also known simply as a home equity loan, and closed end, also known as a home equity line of credit. Both of these types are secured against the value of the home are often referred to as a second mortgage. As such, they will be much shorter in duration than a traditional or first mortgage.
“Home equity, sometimes known as real property value, is the difference between a home’s market value and the outstanding mortgage to be paid on said home.”
The main difference between a home equity loan and a home equity line of credit (often abbreviated to HELOC) is that the former is a one-time lump-sum with a fixed interest rate, whereas the latter is a line of revolving credit with a variable interest rate. A home equity loan is closed-ended, meaning that the duration and terms are set before and the rates and payments remain the same. On the other hand, a home equity line of credit is open-ended, with credit lines that are available for up to 30 years with fluctuating rates.
The characteristics, advantages and disadvantages of a home equity loan:
- A single, lump-sum payment to the borrower suited to large, one-time expenses.
- A fixed interest rate for the life of the loan, allowing for easy budgeting.
- The possibility to borrow 100% of equity or more.
- Loan terms are generally longer.
The characteristics, advantages and disadvantages of a home equity line of credit:
- A line of available credit, much like a credit card and often supplied with one.
- A variable interest rate that changes depending on the market.
- You only pay back what you borrow, with monthly payments based on money borrowed.
- Flexible payment terms, though with a limited amount of credit available
With either type of home equity loan, there are a variety of fees that may apply. For example, an appraisal fee, paid to those who calculate the value of your home. The average appraisal fee is around $300, and is required by the lender so that they know the value of their investment.
There is also an originator or origination fee, paid upon the establishment or opening of a new account. Stamp duties are a tax levied on legal documents, and arrangement or administration fees are those that cover the work of the lender.
Lastly, while a home equity loan can be used towards the purchase price of a new home, the loan will not be made if the existing home is on the market. For this reason, many homeowners look to take out what is called a bridge loan. This allows a seller to buy a new home before selling an existing home with the costs generally being much higher.