The home arguably provides the surest way to raise extra funds, with the availability of home equity loans allowing home owners to tap into free equity. The idea might seem strange, given that an existing mortgage is a major debt. But this is not actually true at all.
Everyone who owns their own home has a valuable asset on their hands. A mortgage loan was needed to secure the property, but as time passes and payments are maintained, the more the available equity grows. And loans approved based on home equity means this value is converted into hard cash.
For those of us with mounting debts, or who have large expenses around the corner, cashing in on the value of the home is a viable solution. But it is important that, when seeking equity loans on the home, all of the pitfalls and particulars are known. This brief guide to some of the main loan aspects can help your application to run more smoothly.
How It Works
First of all, the way that home equity loans work is quite simple. A mortgage is secured in order to buy the home and, month-by-month, this mortgage is paid off. If the value of that loan is $250,000, with monthly repayments of perhaps $1,400 over 25 years, the principal repaid per month may be $1,200. So, after 5 years, around $72,000 will have been repaid.
What that means is that the equity of the home has increased to $72,000, while the market value of the property might also have increased – perhaps by $25,000 – in that time to add further to the value. In all then, a loan approved based on home equity could be as high as $100,000.
The mechanics of equity loans on the home is such that, should $50,000 be needed, that the total remaining mortgage is bought out, and an additional loan of $50,000 is added. That means a total equity loan of $228,000 is granted.
Equity Loan Benefits
However, accessing the extra funds to cover college feeds, business investments or cover medical bills, is only one part of the benefit of home equity loans. The other pluses relate to credit rating. Basically, because the original mortgage is paid in full, and ahead of schedule, the credit rating of the borrower is increased.
What is more, a loan approved based on home equity is a secured loan, which means that the interest rate is lower. This, accompanied with the repaid mortgage means that a far better deal can be enjoyed. So, not only is the second loan lower, but the monthly repayments are lower too, perhaps by as much as $100 per month.
This releases further funds into your pocket, making equity loans on the home a sound financing option.
Where the Risks Lie
But there are still risks to a home equity loan that should be considered. The most obvious one is that failure to repay can mean losing your home, since the loan is issued with the home as the security.
The second risk is one that can be easily avoided, relating to the value of the loan approved based on home equity. If too much is borrowed then borrowers run the risk of financial instability.
With regards our example, it might be tempting to seek the maximum equity – all $100,000 – but this would mean a higher sum than the original, and higher repayments. In such a case, equity loans on the home can destablize finances completely, resulting in bankruptcy.
It is also important to remember that a host of fees are associated with home equity loans, from attorneys fees to property revaluation costs. These have to be factored into the overall worth too.