A home equity loan can be both useful and dangerous. It is important to know what a home equity loan is and what types are available before commiting to such a loan.
There are a number of reasons you may consider taking out a loan - such as paying for a child's education, compensating for a lost job or simply investing in a new business or property. If you are looking for a little extra money and you own a home, you could consider taking out a home equity loan.
Home Equity Loan Basics
A home equity loan, sometimes called a 'second mortgage,' is a type of loan given to homeowners. In exchange for the money, the homeowner's home is offered as collateral. The home's equity is based upon how much the home is worth and how much of the home is already paid for. To calculate your home's equity, subtract the mortgage from the home's current value.
Types of Home Equity Loans
The text shown above is a simple definition of home equity loans, but there are actually several types of home equity loans from which you can choose.
The most popular is the standard home equity loan. This loan is also known as a term or closed-end loan or second mortgage installment loan. Like a traditional loan, you are given a lump sum of money and assessed a fix interest rate. You then make payments on a monthly schedule until the loan is paid off. Once the loan has been paid, you regain complete ownership of your house.
A second type of home equity loan is called a home equity line of credit. This type of loan, just as with other lines of credit, offers you an amount and places it in an account from which you can draw money as needed. While you are only responsible for paying interest on the amount actually withdrawn, the interest rate is flexible, meaning it can fluctuate. A fixed rate is often preferred because you know before accepting money the exact amount you'll be expected to repay. A flexible rate does not offer the same security.
A third option, cash out refinancing, is not precisely a home equity loan, but does allow you to borrow against your home's value. In this scenario you actually take out a new home mortgage that is worth more your home's value. Your payments will then increase, with some of the money going toward paying off the actual home and the rest toward the home equity-like loan.
Before You Consider a Home Equity Loan
As with all types of financing, home-equity loans can be dangerous, but necessary. It is important for you to never bite off more than you can chew. Before accepting a loan, you should truly evaluate whether the purchase is worth the risk. If it is, you should be certain that you can afford the payments. Failure to pay on the loan may result in foreclosure.
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