If you're a homeowner, chances are that you've been deluged with offers
from finance companies to lend you money based on the equity you have
invested in your home. A home equity loan is a loan extended to you
that is secured by your home. The amount of the loan is based on how
much 'equity' you have invested in your home. The basic explanation of
'equity' is 'the difference between your home's value and how much you
still owe on the mortgage'.
In other words, if you bought your home for $125,000 and put $20,000
down on it, financing $105,000, then your equity in your home on the
day that you close the deal is $20,000. Now imagine several years pass.
You've paid off $15,000 toward your mortgage - but at the same time,
the value of your house has increased to $175,000. Your equity in your
home is now $85,000: $175,000 (your home's current value) - $90,000
(the amount you still owe on your home) = $85,000.
A home equity loan allows you to turn the equity you have in your home
into cash by borrowing money and using your home as collateral to
insure that you'll repay it. If you default on the loan, the bank or
housing agency can force the sale of your home to recover its money.
There are many reasons that people apply for home equity loans, though
most fall into a few broad categories. The reason for taking out a home
equity loan will often determine what kind of loan you apply for.
Debt Consolidation
By far one of the biggest reasons that homeowners apply for a home
equity loan is to consolidate their debts. If you have outstanding debt
to several different creditors at several different interest rates,
it's often to your benefit to consolidate all those loans. To do that,
you can take out a home equity loan for the amount that you owe on all
your debts together - or more - then use that money to pay off all your
outstanding debts in full. By doing that, you trade writing several
checks each month for writing one check, which is often less than the
amount that you've been paying on all of the debts combined. This is
because you're also trading in the higher interest rates on your credit
cards and loans for a lower interest rate on one loan. Chances are that
you've also set a fixed time to pay back that loan, most often 15
years, though it could be as little as five or as much as thirty.
Home Improvements
If you want to make improvements or repairs to your home, it only makes
sense to get the money OUT of your home to do it. Home improvements are
one of the top five reasons that homeowners give for taking out home
equity loans. If the reason for making improvements is to increase the
home's value or prepare it for a sale, then you should definitely take
a look at the home improvements that return the most on your
investment. In many cases, when the reason for taking out a home equity
loan is to pay for home improvements, the homeowner applies for a home
equity line of credit rather than a flat out loan.
Weddings, Vacations and College
Special events like weddings and vacations are the third most popular
reason for taking out a home equity loan. For a wedding or other
special event, where there will be multiple payments made to different
merchants, a home equity line of credit is often a better choice than a
lump sum home equity loan.
