Home Equity Loans

Equity Loan Quick Facts

• Home equity loans are second mortgages.
• You can usually get approved for a home equity loan even if you have bad credit.
• They are most often used for home improvements, car purchases or to consolidate credit card and other high interest rate debt.
• All interest paid on a home equity loan up to $100,000 is usually tax deductible (check with your accountant to make sure).
• You can borrow more than your home's worth (up to 125%) depending on your credit and what state the property's located in.
• Beware of balloon payments. Most people avoid balloon payments, so remember to ask your lender if the loan you're interested in has a large balloon payment.

How do I get a home equity loan?

Applying for an equity loan or home equity line of credit is much less rigorous than applying for your first mortgage. Along with sufficient equity in your home--an appraisal will determine its value--your credit must be in good standing, your total indebtedness must meet qualifying ratios, and you must document your income to verify your ability to pay both loans.

Your home must yield an adequate amount between your loan balance and the value of your home. Lenders typically offer competitive market interest rates for a home equity loan (second mortgage) that, combined with your first mortgage, won't take your total home-secured indebtedness beyond 70% to 90% of the value of your home, leaving you with an equity cushion.

You can obtain equity loans with less or zero equity. Loans up to 125% or more of your home's value come with much higher interest rates, perhaps more fees and more stringent qualifying restrictions.

Using Home Equity Loans for Debt Consolidation

To make home equity loans work as a debt consolidation tool follow these helpful tips:

• Change your spending habits. Before you apply for the loan, practice living on a lower income. Save the difference. Don't take on additional debts while the equity loan is outstanding.
• Choose a short payment period. Even with a low interest rate a 10 to 15 year home equity loan can be expensive. Prepay your loan in three to five years. The savings can be startling. If you transfer a $15,000 balance of just one 17 percent credit card to a 9 percent home equity loan and pay it off in five years, you'll save more than $30,000.
• Avoid loans for more than the value of your home. Not only can't you deduct all the interest but you'll also put your home at unnecessary risk for a costly loan.
• Shop around for the lowest rate.
• Avoid high closing costs, low introductory or "teaser" rates and credit cards tied to home equity lines of credit. They all undercut your reason for consolidating -- to save money.

Home Equity Line of Credit (HELOC)

Often you will come across the term HELOC meaning home equity line of credit in the world of loans and mortgages. Sometimes it is also referred to simply as home equity line. Basically the way the home equity line of credit works is that you borrow an amount of money from a lender upon which you can draw whenever you need it. Say you take out a HELOC worth $100,000 dollars. The lender will not make the entire $100,000 available to you after the closing of the loan as is the case with a regular loan or mortgage. Instead you are able to draw upon this amount whenever you are in need of cash. You can do so by writing out a check or using a special credit card. There are other ways of obtaining the cash which can be agreed upon with the lender.

The HELOCs have some interesting advantages which have caused an increase of people obtaining this form of financing. These advantages include:

• The possibility to draw out cash at your own convenience.
• Interest is only charged upon the amount you withdraw.
• Low up front fees.

The home equity line of credit can be very advantageous when you are in need of swift cash for example to make an improvement in your house or pay for your child's school or college tuition.

However, there are certain aspects of this type of financing which can be very tricky and may land you in some trouble. This may seem like an ideal solution for you but it is important to know the ins and outs of this loan type.

The repayment of a home equity line of credit can work in different ways. This depends on the agreements you make with the lender before you close the loan and will also be stated in the loan agreement. Often you will have a withdrawal period of 10 years. In this time you can withdraw the money whenever you wish and the balance will be calculated on a daily basis. During this period you will only pay the interest.

After the 10 year withdrawal period (this is not always 10 years, but we use it as an example here) you will be required to pay the of the amount loaned divided by the amount of months in the so-called repayment period. This period often stretches over 10 years.

But, it can be that a lender will require you to pay the full amount in one go after the withdrawal period is over which might leave you in some financial distress. However, this should be agreed upon before the closing of the loan.

In our page on the adjustable rate mortgages you will have been able to read all about that loan type. The home equity line of credit is also, without exception, an adjustable rate mortgage meaning the interest rate will fluctuate during the life of the loan. However, the change of interest rates in regard to the HELOCs have drastic consequences for the borrower. Should the interest rate change at a certain point (most often the end of the month) the interest rate for the home equity line of credit will change not long after it (often the first day of the next month). So, if the interest rate increased significantly, your payments will of course also increase significantly leaving you with higher payments minus the time to come to terms with it.

This is a major stumbling block for this type of financing and it requires a lot of thought before you attempt to apply.