Your Equity Loan: 4 Key Facts

An equity loan is a fast way for homeowners to secure cash. In this special type of mortgage, people can tap the equity of the home in order to obtain a line of credit or cash during emergencies, such as unexpected medical or college expenses. Simply put, this kind of loan puts a lien on your property. To illustrate, a person who owns a house worth $200,000 can obtain credit of about 80% LTV (loan to value) or cash of $160,000. In exchange, however, the lender will place a lien on the title of your property.

Below are the key facts that you need to know about equity loans:

Requirements for Obtaining an Equity Loan

Almost anybody who owns a home whose title is not placed in lien can secure a home equity loan, which is also called as second mortgage. Your home equity will be your collateral for your credit. Also, you need to show the lender that you have a good credit history plus a way to repay the loan you are applying for. Thus, you should not be surprised if your lender asks for various documents, which may include income tax returns spanning several years, to ascertain your capacity to pay.

By the way, you do not have to secure the maximum amount of loan when you apply. It would be best if you just borrow the money that you need. However, in case you need more, you can always negotiate with your lender.

Major Types of Equity Loan

There are two major types of home equity loan. The first one is known as the fixed-rate loan and the other is line of credit, also known as HELOC or home-equity line of credit. Both types have payment terms that can range from 5 to 15 years. Another similarity is that both facilities would require you to pay in full in case your collateral is sold. The main difference, however, lies on their interest rates. The fixed-rate loan has unchangeable interest rate for the whole duration of the loan, while HELOC has variable interest depending on the prevailing rate.

Benefits of This Loan

Equity loans have various benefits. One of which is that it is an easy and fast way of obtaining cash. In fact, a number of people who tap their home equity to get cash use the loan proceeds for emergency needs. Furthermore, the interest rate applicable to home equity loans is usually lower than what is charged on other consumer loans and credit cards.

Risks of Taking Out Equity Loan

One of the major pitfalls of equity loans is that many people use them as an easy solution to pay for other loans or debts, particularly credit cards. In theory, there is nothing wrong with using equity loan to consolidate your credit card debts. The problem, however, lies in the fact that many individuals who get equity loans to pay for credit cards get into the habit of reloading. After paying the credit card debts using equity loans, some people use their credit card balances in no time. As a result, they have to deal with two or more obligations, instead of one.

Since most lenders require borrowers to pay interest monthly and a balloon payment at the end of the loan term, many people end up borrowing money again in the future to pay for the balloon payment which they were unable to prepare for. These risks, however, can be easily avoided if you know when is the right time to use your home equity to secure credit.