Home Equity Loans - How They Work & What Are Their Benefits

Home Equity Loans are large scale loans available to home owners. These loans can be used in a variety of ways and come with some unique benefits that can benefit any homeowner.

Home Equity Loans Rundown

Owning a home is often regarded as the epitome of the American Dream. A home comes with many benefits, such as independence, stability, and pride.

Owning a home also unlocks with it some financial abilities as well. One of these abilities is access to a home equity loan, often referred to as a second mortgage. Home equity loans can be a beneficial tool but before using them, you should be aware of their details.

What is a Home Equity Loan?

Home equity loans are loans borrowed from financial institution using the value of the home as collateral. This means that the loan is based upon the value that one’s home, thus, loans can be limited depending on how much the property is worth. These loans, although often called a “second mortgage”, don’t have to be exclusively for a real estate.

Therefore, one can use the borrowed money for education, new vehicles, medical expenses, etc. There are two different types of home equity loans: closed-end & open-end.

The closed-end is the more traditional home equity loan, with a set amount money and payment period, similar to a personal loan. The open-end is more of a credit line. The lender gives the borrower access to credit and the borrower can withdraw money against credit.

So what’s the catch?

Provisions You Should Know About Home Equity Loans

Due to the nature of a home equity loan, there are certain stipulations associated with them. First, the borrower must obviously have a home. However, having a home is just the first part. The borrow will also need to have equity in the house, which means they have paid off some portion of their mortgage, before receiving a loan. This is where the name “home equity loan” comes from.

Without equity, a lender could end up losing money as the borrower would essentially be borrowing money on already borrowed money: their original mortgage. This is referred to as loan-to-value ratio (LTV). The standard LTV for receiving a home equity loan is 80/20, with the borrower having 20% or more equity in the home.

Another key requirement for a home equity loan is good credit. While some lenders are willing to lend to riskier clients, a home equity loan is not one of those. Because of their nature and often large monetary amounts, home equity lenders do not often lend money to borrowers with bad credit.

Closed-End Loan

For a closed-end loan, the borrower will receive a lump sum of money all at once and then given minimum payments and a time period for repayment with set interest rates. This is usually a shorter time period than that of traditional mortgages, with more closed-end home equity loans being 5-15 year periods. Very similar to a typical mortgage.

Open-End Loan

A open-end loan is a bit more complicated. When a borrower takes out a open-end home equity loan, it is broken down into two key parts. The first part is the credit part called the draw period. The lender will open a line of credit for a period of time, usually a 5-15 year period. During this period, the borrower may withdraw money as they need it. The payments in the draw period of limited to interest only.

The next period is the payment period. This is when the borrower will begin to repay interest remaining and the principal amount borrowed. The payment period is usually a 10-20 year period.

What’s in it for you?

Benefits of Home Equity Loans

There are many benefits associated with home equity loans. The most prominent is the ability to borrow large amounts of money. Because of their association to a borrower’s home, lenders are willing to lend much more money with a second mortgage than a typical personal loan. This gives a borrow more options when it comes to using borrowed money.

Home equity loans also have long repayment periods, with most being at least 10 years in length, and often reaching 20 years. This again benefits a borrower, as they can use this money for more long-term investment.

Lastly, home equity loans have lower rates than most loans, especially credit cards. This is especially good for those who usually repay their debts over longer periods of time.

Overall, home equity loans, or second mortgages, are a beneficial way to borrow money. With their simple terms and great timeframes, a homeowner is need of more money can easily benefit from using a home equity loan wisely.

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