There are two types of home equity debt: home equity loans and home equity lines of credit, also known as HELOCs. Both are sometimes referred to as second mortgages, because they are secured by your property, just like the original, or primary, mortgage.
Home equity loans and lines of credit usually are repaid in a shorter period than first mortgages. Most commonly, mortgages are set up to be repaid over 30 years. Equity loans and lines of credit often have a repayment period of 15 years, although it might be as short as five and as long as 30 years.
A home equity loan (HEL) is very similar to a regular residential mortgage except that it typically has a shorter term and is in a second (or junior) position behind the first mortgage on the property - if there is a first mortgage. With a home equity loan (HEL), you receive a lump sum of money at closing and agree to repay it according to a fixed amortization schedule (usually 5, 10 or 15 years) with the same payments each month. Much like a regular mortgage, the typical HEL has a fixed interest rate that is set at closing for the life of the loan. Such loans are typically granted for up to 80% of the value of the home, but some lenders will lend up to 125% of the home's value.
For example, if your home is currently worth $130,000, and you have a mortgage against it for $70,000, then you have $60,000 of equity available. Some home equity loans may allow you to borrow up to 80% of your home's value, others may go higher in special circumstances.
This loan is very suitable for people who need money in a long term and own any home or property. With this kind of loan, borrower can lend an amount of money equivalent to the equity of their property without selling it. While the lender will lend the money in safety as they hold the guarantee if the borrower can't pay the money they lend.
The idea of getting a home equity loan while interest rates are low to help you pay off your bills, buy a car, or even pay for your child's education may seem like a great idea. However, you should educate yourself first so you know exactly what a home equity loan is and if it is really right for you.
A home equity line of credit (HELOC) in many ways is similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to a certain amount for the life of the loan - a time limit set by the lender. During that time, you can withdraw money as you need it. The borrower is usually given special checks that he or she may use to write checks against the loan amount. The borrower may borrow a little at a time, or borrow all of the loan amount at once. As you pay off the principal, you can use the credit again, like a credit card.
HELOC funds are borrowed "on demand" and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement beyond the minimum, it is up to you how much to pay and when to pay. One more important difference: the interest rate on a HELOC is adjustable meaning that it can - and almost certainly will - change over time.
A HELOC can be most useful if you are taking on a project, such as home repair, that has the potential of unforeseen expenses. A HELOC offers you the flexibility to borrow again and again. You may even be able to secure a HELOC that carries a low interest-only payment allowing you to borrow more and still have a manageable payment amount each month. Whichever you choose, drawing against the equity in your home is sure to save you money on the interest you're paying for your purchase power, and as always, the interest you pay on any type of home mortgage is tax-deductible, offering an additional incentive.
Home equity loans and home equity line of credit can be a wonderful tool when used correctly. Do your homework first, find the loan that best matches what you want, and go for it. Just make sure you don't over extend yourself or sign documents that will give you nightmares forever.
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