Updated:Wed, Apr 23rd 2008The Home-Equity Loan: What It Is And How It Works
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Home Equity Loans
Ame & equity new loan from also $1.65 known as a second Excerpt mortgage - lets page homeowners 127: borrow "... money with by a leveraging down the payment. equity Parents in may their have homes. a home lot equity of loans equity exploded in in their popularity own in homes. 1996 They as can they tap provided home equity loan, also known as a second mortgage, lets homeowners borrow money by leveraging the equity in their homes. home equity loans exploded in popularity in 1996 as they provided a way for consumers to somewhat circumvent that year's tax changes, which eliminated deductions for the interest on most consumer purchases. With a home equity loan, homeowners can borrow up to $100,000 and still deduct all of the interest when they file their tax returns. Here we go over how these loans work and how they may pose both benefits and pitfalls.
Two Types of home equity Loans
Home equity loans come in two varieties - fixed-rate loans and lines of credit - and both types are available with terms that generally range from five to 15 years. Another similarity is that both types of loans must be repaid in full if the home on which they are borrowed is sold.
Fixed-Rate Loans
Fixed-rate loan provide a single, lump-sum payment to the borrower, which is repaid over a set period of time at an agreed-upon interest rate. The payment and interest rate remain the same over the lifetime of the loan.
home equity Line of Credit
A home equity line of credit (HELOC) is a variable-rate loan that works much like a credit card and, in fact, sometimes comes with one. Borrowers are pre-approved for a certain spending limit and can withdraw money when they need it via a credit card or special checks. Monthly payments vary based on the amount of money borrowed and the current interest rate. Like fixed-rate loans, the HELOC has a set term. When the end of the term is reached, the outstanding loan amount must be repaid in full.
Benefits for Consumers
home equity loans provide an easy source of cash. The interest rate on a home equity loan - although higher than that of a first mortgage - is much lower than on credit cards and other consumer loans. As such, the number-one reason consumers borrow against the value of their homes via a fixed-rate home equity loan is to pay off credit card balances (according to bankrate.com). Interest paid on a home equity loan is also tax deductible, as we noted earlier. So, by consolidating debt with the home equity loan, consumers get a single payment, a lower interest rate and tax benefits.
Benefits for Lenders
home equity loans are a dream come true for a lender, who, after earning interest and fees on the borrower's initial mortgage, earns even more interest and fees. If the borrower defaults, the lender gets to keep all the money earned on the initial mortgage and all the money earned on the home equity loan; plus the lender gets to repossess the property, sell it again and restart the cycle with the next borrower. From a business-model perspective, it's tough to think of a more attractive arrangement.
The Right Way to Use a home equity Loan
home equity loans can be valuable tools for responsible borrowers. If you have a steady, reliable source of income and know that you will be able to repay the loan, its low interest rate and tax deductibility of paid interest makes it a sensible alternative. Fixed-rate home equity loans can help cover the cost of a single, large purchase, such a new roof on your home or an unexpected medical bill. And the HELOC provides a convenient way to cover short-term, recurring costs, such as the quarterly tuition for a four-year degree at a college.
Recognizing Pitfalls
The main pitfall associated with home equity loans is that they sometimes seem to be an easy solution for a borrower who may have fallen into a perpetual cycle of spending, borrowing, spending and sinking deeper into debt. Unfortunately, this scenario is so common the lenders have a term for it: reloading, which is basically the habit of taking a loan in order to pay off existing debt and free up additional credit, which the borrower then uses to make additional purchases.
Reloading leads to a spiraling cycle of debt that often convinces borrowers to turn to home equity loans offering an amount worth 125% of the equity in the borrower's house. This type of loan often comes with higher fees because, as the borrower has taken out more money than the house is worth, the loan is not secured by collateral. Furthermore, the interest paid on the portion of the loan that is above the value of the home is not tax deductible.
See more:
Why Home Equity Loans & Lines Are Popular
Ways to Use Your Home Equity Money
Pros and Cons of Home Equity Debt
How to Choose Between a Loan or 'Line'
What Home Equity Lenders Look For
The Cost of a Home Equity Loan
Refinancing a Home Equity Loan
High Recommended Books
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| The New Reverse Mortgage Formula: How to Convert Home Equity into Tax-Free Income by Tom Kelly (Paperback - Mar 1, 2005) |
| Buy new:$14.96 26 Used & new from $7.50 |
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 a second Excerpt mortgage - lets page homeowners 127: borrow "... money with by a leveraging down the payment. equity Parents in may their have homes. a home lot equity of loans equity exploded in in their popularity own in homes. 1996 They as can they tap provided that a equity way with for a co home-equity loan |
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| Excerpt - page 29: "... In a traditional, forward mortgage, the borrower starts with little equity in the home and a large loan balance. ..." | | |
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| Who Says You Can't Buy a Home! by David Reed (Paperback - May 30, 2006) |
| Buy new:$14.00 65 Used & new from $3.79 |
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| Excerpt - page 26: "... With such demand, naturally home values increased. When home values increase, homeowners accrue equity not by paying down the loan and regaining their principal, but by the appreciation in home ..." | | |
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Link to Page:
The Home-Equity Loan: What It Is And How It Works
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