What Is a Home Equity Loan?

You may have heard about home equity loans periodically over the years. However, you may not know what is a home equity loan or how this type of financing may work for you. Equity essentially is the difference between what the current market value on your home is and what you currently owe on home loans. Home equity is established with your down payment at the time of purchase. It grows over the years through periodic loan payments as well as through appreciation of property value. A home equity loan lets you tap into that equity for various purposes.

The Concept of a Home Equity Loan

When you ask what is a home equity loan, you need to know where the concept originated from and how these loans first started being used by homeowners. At one time, the American Dream included buying a home with a mortgage and working hard over the years to pay the loan off.

Many people did not retire until their home loan was paid off and their home was owned free and clear. They obtained a single mortgage loan over the years, and they rarely refinanced it or took out secondary financing.

However, some homeowners have realized that there may be benefits associated with using the amount of equity they have accumulated in their home over the years in different and positive ways.

For example, is it better to pay off your high-interest rate credit card debt with the very low-interest home loan? Remember that interest on a home loan is also tax deductible.

Some homeowners have also realized there may be a financial advantage to restructuring the debt on their home loan. They would do this by restructuring at strategic times based on current market conditions.

For example, they may want to refinance a second lien to take advantage of a lower rate. When you ask what is a home equity loan, you need to understand that the concept of a home equity loan arose through these two primary concepts.

Advantages and Disadvantages of a Home Equity Loan

Like with any type of financing, there are both pros and cons associated with home equity loans to consider. When you analyze what is a home equity loan, you will see that some of the pros apply to you. Some of the cons will be applicable as well.

It is up to the individual homeowner to analyze the pros and cons carefully. After that to decide what the most intelligent and financially beneficial course of action is.

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Advantages of a Home Equity Loan

When you want to know what is a home equity loan and how this type of financing could benefit you, you should take into account the following advantages.

1. It is linked to low interest rates in comparison to other types of financing

This is because the equity in your home is used as collateral. Most real estate lenders only lend up to 75 or 80 percent of the value of the home.

This leaves ample remaining equity in the home to cover a reduction in property value and other negative possibilities.

2. You may qualify for this type of loan easier than for another type of financing

Because your home is used as collateral, some lenders are more lenient with lower credit ratings or negative credit events.

However, you do need to have a substantial amount of equity available in your home. You need it in order to qualify for this type of loan. Credit scores may not be as important to a lender as the amount of equity that you have available.

3. It may offer the same benefits as a first lien home loan

When you take a closer look at what is a home equity loan, you will see that this type of real estate loan offers many of the same benefits as your traditional first lien home loan.

For example, you may be able to write off the interest on this loan as a tax deduction. There is also a considerable financial benefit regarding this.

Depending on the amount of equity available in your home, you may qualify for a large loan amount. Remember that unsecured loan amounts typically cap at a moderate amount and may not always meet your specific financing needs.

Disadvantages of a Equity Loan

After you ask what is a home equity loan and you learn about the benefits, you may be ready to apply for a loan and to start taking advantage of this type of financing. However, remember that there are also a few drawbacks to a home equity loan that you should consider.

1. A home equity loan is usually a long-term debt

If you have plans to consolidate credit card debt into a home equity loan, you may actually be extending your repayment period in some cases as a result of the long term on a home equity loan.

2. The application process for a home equity loan can be lengthy and tedious

In fact, applying for a home equity loan may be very similar to applying for a first lien home loan, such as when you originally purchased your home. You may even have to require a new appraisal, and there is a substantial fee for this.

3. A home equity loan uses your home as collateral

In the event that you default on your loan, your home equity lender can potentially foreclose on your home in an effort to recoup the money that you owe. This means that your home is at stake.

Before you take out a home equity loan, you should carefully review your finances. Ensure that you are comfortable with the loan payment.

In addition, you may also want to have a substantial rainy day savings account balance. So that you can make payments on your home loans in the event you lose your job or run into other issues.

Conclusion

After you ask what is a home equity loan, you can see that this type of financing is beneficial to homeowners. However, it is only available to homeowners who have worked hard to establish equity over the years. If you want to take advantage of the benefits of a home equity loan, you should first review your home’s current value and current loan balances to estimate your equity. If you have any previous experiences with home equity loans or other comments that you would like to share, please feel free to use the space below.