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Understanding an Equity Loan

An equity loan is exactly what the name implies, a means of taking out a loan based on the built up equity in the home. The key is for the homeowner to get the best possible service and loan options possible, and to play an active role in the lending process. It is true that the lender would provide the services needed but the homeowner should also spend a little time and effort into researching the home equity loan so he or she knows what is needed versus wanted. Some of the things that the homeowner should consider include:

  • Because the home is used as the collateral against a home equity loan, doing everything possible not to jeopardize the property should be the homeowner’s number one priority.
  • It would be beneficial if some of the money received for a home equity loan were used to pay down or even eliminate credit cards, especially those with high interest rates. Most often, the reason a person takes out a loan such as this is to get out of debt and credit cards are dangerous from a financial perspective. While one credit card might be kept for emergency purposes only, the homeowner needs to be prepared to make some budgeting decisions to avoid a difficult financial situation in the future.
  • It is very important that the homeowner work with a reputable lender, one that has their best interest in mind. Most often, the original lender would be the best place to start but sometimes, it pays off to look at other lenders too. A good lender would be one that considers the homeowner’s needs and the amount of equity in the home, providing guidance. As an example, if $50,000 were built up in equity but the person only needed to borrow $20,000, the lender should recommend that only the amount of money needed be borrowed, leaving the remainder as equity. Borrowing the full amount of equity is probably the quickest way to get into trouble in that the homeowner ends up over extending all of his or her financial resources.
  • By taking out a home equity loan only for the money needed leaves funds available just in case a future emergency were to arise.
  • One of the most common mistakes made by people that take out a home equity loan is that they fail to read the fine print in the contract or agreement. People should always read every word and for any questions, they should clarify things with the lender before signing on the dotted line.
  • The homeowner should also consider his or her current employment situation. Unfortunately, the job market is tough right now and while no one wants to think about losing a job, it is better to be realistic and prepared than surprised.
  • The money that comes from a home equity loan should never be used for handling daily expenses. Most often, this money is used to get out of debt, purchase a new vehicle, remodel or update the home, or perhaps send a child to college.

Homeowners that use a “cookie-cutter” approach for a home equity loan generally end up with a mess. The reason is that every person has a different situation, one that requires a specific amount of money so the loan should be tailored to that person’s need. Most companies specializing in home equity loans realize the importance of providing the homeowner with a unique solution, which is why they try to be flexible.

A home equity loan that has been carefully tailored to the homeowner’s needs means getting the lowest interest rate possible, having an easy repayment schedule, and securing the right type of financing. A person needing an equity loan has various options, one of the popular choices being a line of credit. This type of loan allows the person to borrow the difference between what he or she owes on the property and the current value, or equity.

A home equity line of credit (HELOC) is the difference between what the property is worth and what is still owed on the mortgage. By using the equity in the home, the person could qualify for a sizable amount of credit, available to use when and how wanted. Typically, the interest rate on these loans is based on the prime rate plus a margin. To determine the actual amount of credit for the home equity loan, the lender would look at the homeowner’s ability to repay based on income, debts, and other financial obligations, as well as credit history.

If the person borrowed $30,000 and paid the money back as agreed, that money could be borrowed again in the future. In other words, home equity loan as a line of revolving credit uses the property as collateral. Therefore, the funds are often accessible through an account on which the borrower writes checks that become a series of "mini-loans" against the equity. In this case, when those small loans are repaid in addition to interest, the homeowner could use the equity repeatedly.

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