Being a homeowner gives you a huge benefit: whenever you make payments towards your mortgage, you build equity in the property. After a while, you can take advantage of this equity and get what is known as a home equity loan.
This is a financing type offered by home loan lenders, and it is similar to a mortgage – which is why so many view it as a second mortgage. If you’ve built equity and think about getting this type of loan, you should know exactly what it is and how it can help you.
Luckily, this article is packed with all the information you want to know about home equity loans.
What Are Home Equity Loans?
A home equity loan is a type of loan offered by home loan lenders. It lets you borrow against the equity you’ve built as a homeowner.
Equity refers to the amount of ownership you have over your house. It shows the difference between the amount you owe on the mortgage and the present value of the home.
For instance, you may have bought a home for $400,000, yet as time went by, this value increased, reaching almost double the amount. This means that the property is worth way more now than it was back when you made the purchase.
So, if your house is now $800,000 and you have to pay $400,000 back on the mortgage, you own the remaining $400,000.
With home equity loans, you can borrow against this equity, using the equity you’ve built as collateral for the loan.
The Different Types of Home Equity Loans
Home equity loans are available in two different types. Therefore, you can get them as:
- A line of credit – The person who borrowed can borrow again until they reach a previously settled limit. They might also reborrow if they need this. The repayments will change according to the sums taken out using the line of credit.
- A lump sum – An individual reborrows a lump sum approved by the lender. As time passes by, the borrower can start making adjusted repayments.
Can You Use a Home Equity Loan for Any Purchase?
Here’s a question that many homeowners might have when it comes to home equity loans: can you use them to pay for anything, or should they only be used for specific purchases?
Home equity loans are only suitable for some purchases. For example, you can use the money to buy an investment property or buy yourself a business.
The money can also be used for debt consolidation. If you have existing debt and the interest rate is too high to deal with, consolidating your debt can help you reach better rates. In the end, managing your finances will be much easier.
Lastly, you can use the money from the home equity loan to make renovations to your home. If you love the new house and want to turn it into your forever shelter, then your home equity loan can help you meet the money requirements for renovation projects.
How Do They Work?
By getting a home equity loan, you receive an amount of cash based on how much equity you’ve built in your house, then spend it on home improvements, debt consolidation, or other purchases.
Each home equity loan lender is different and is willing to offer different amounts based on your home’s value. Many lenders are willing to give you at least up to 80% of the LVR or loan-to-value ratio of the house. They’ll do this either as a line of credit or a lump sum. But you may be lucky enough to find lenders who can lend you more than 80% in LVR.
Although this is possible, you might have to take out an LMI or lender’s mortgage insurance to get the higher LVR. This serves as a security for the risk the lender takes.
Pros and Cons of Home Equity Loans
Home equity loans can be very advantageous, but they also have a few drawbacks. You must be aware of them before taking this kind of loan.
- Compared to other types of loans, getting approved for a home equity loan is generally more likely to happen
- Interest rates for home loans are usually not as high as the ones you see for credit cards, personal loans, and other types of financing, which is all thanks to how secure home equity loans are
- With a home equity loan, you can unlock equity in your house that you can use to make important investments
- They are quite flexible, as you can use them for almost any purpose
- You may have to deal with charges
- A home equity loan means additional debt, giving you one extra financial responsibility
Home equity loans are great for people who were able to build a lot of equity and wish to borrow against it for different reasons. Before borrowing, make sure you are fully prepared to take more debt and that you’re aware of the potential downsides.