What Borrowers Should Know About Home Equity Loans

A home equity bank loan is one of the most common forms of loan. It is often called a second mortgage because it involves taking an additional loan out against the equity and value of the house after you've paid down at least part of the original mortgage. This sounds complex, but you can understand it if you break the loan into its pieces.

What Is Home Equity?

First, you need to understand what home equity is. You derive home equity from two sources.

Paying down your mortgage generates equity. As you pay more on the principal, your equity increases until you pay off the loan in full. At that point, all of the equity in the house belongs to you.

Increasing market values can also generate equity. If you took on a mortgage to buy your house 20 years ago, there's a good chance the value of the house has gone up. Nationally, the real estate market has seen improving home values. These increases in market value also drive up your equity.

A Loan Collateralized by the Equity

Your home's equity is a potential source of collateral for another loan. If you want to pursue a home equity bank loan, the lender will order an independent appraisal. The appraiser will provide the lender with a market valuation for the house, and then the bank can offer a loan based on the full equity.

Two Kinds of Loans

There are two types of home equity loans. First, you can get a fixed-rate loan that functions like most mortgages. Second, you can get a home equity line of credit. This is a continuing financial instrument that allows you to borrow against the equity. Notably, it is a variable-rate loan. You don't have to borrow the full amount, though.

Why Use One?

People obtain home equity loans for numerous reasons. If you've owned your house for a long time, it might be time to remodel. A loan can fund renovations. Homeowners also use equity loans to take vacations, buy vehicles, pay for their kids' college tuition, and start businesses.

Financial advisors often talk about homes as the biggest asset that most people have, and equity is why. You can leverage the equity for a variety of purposes. Some folks even use their equity to buy rental properties or vacation homes, allowing them to grow their wealth beyond their primary residences.

Contact a professional for additional info