Taking out a loan against the equity in your home can open the doors to much bigger funds, but it’s a risky move. Let’s check out the concept first: a home equity loan occurs when a homeowner borrows money against the market value of their property as an exchange for a share of the property.
As we mentioned before, this type of loan grants access to large amounts of cash and, since it’s a secured type of loan that is backed up by your property, it’s considered an easy way to qualify, however, that doesn’t mean you’ll qualify for a great rate.
Another name for home equity loans is “second mortgages”, and the first one was when you took a loan to purchase the property in the first place. That first mortgage is the one that allows the house to build equity and that’s what banks use as a guarantee. As you can see, significant risks are involved.
How do home equity loans work?
When a bank approves you for a home equity loan one of two things will happen:
- You receive a lump sum of money and then you pay it back under the terms and installments agreed. As for interest rates, those are arranged from the very beginning and should remain fixed for as long as the loan lasts. When you pay each month, some of the money goes to cover interests and the rest will reduce the loan balance.
- You receive a line of credit which technically works like a credit card. There’s a maximum amount available and you take from it according to your needs and make your repayments monthly, like a credit card.
Evidently, the line of credit is more flexible than a lump sum as you have slightly more control over the balance owed and most importantly, you have more control over interests cost as you pay them only based on the amount you’ve used up to that point.
Keep in mind the terms and conditions and how the creditor can, without letting you know, freeze the funds and make them unavailable, so beware for when you rely on that money so the bank doesn’t let you down when you need it the most.
Finally, there’s usually no fixed rates for lines of credit so they may fluctuate against you. Make sure that you explore all options available with your bank before making a decision.
How do repayments work?
It depends on the type of loan you received. Repayment amounts will usually be the same for a lump sum loan for the life of the loan which is somewhere between 15 – 20+ years. Lines of credit will have a shorter lifespan and draw periods can last up to ten years.
Positives of Home Equity Loans
If homeowners have sufficient equity, it grants access to much larger funds that otherwise may be unavailable. All home equity loans will have a much lower interest rate than any other type of loan, and the money you receive is not obliged to be used only for house-related use.
It represents a big help so people can accomplish major goals, like home improvement projects, education or even start a business of their own.
Negatives of Home Equity Loans
The major risk that home equity loans have is the fact that if not handled with care people can lose their property, which is a big deterrent. This happens mainly because people are unable to meet the monthly repayments and the banks start a foreclosure process towards their home. If successful it means that the bank will sell the house in order to get the money back.
This means that borrowers should make this particular debt a top priority or think things through before saying yes. The worst part is that closing costs can be extremely high, so be careful because you may be risking too much just to get your hand on some cash.
It’s recommended to check for alternative sources of financial support, such as checking for your unclaimed PPI or looking into 0% interest credit cards for a specified period of time.