What’s A Home Equity Loan?
A home equity loan is a loan where you, as the home owner and borrower, use the equity in your home as collateral for the loan. If you take out a home equity loan, it will create a lien against your property and in effect, reduce the actual equity you have in it. Such a loan is often referred to as a second mortgage, because it’s secured against the value of the property, just like a traditional mortgage.
Often, home owners will take out home equity loans for large home repairs or to pay bills. As with any loan, careful consideration must be given before taking out a loan against your home. Make no mistake, the security for a home equity loan is your house. When it’s used as collateral, and if you are unable to make the payments, the lender will take possession of your most precious asset to satisfy the loan. I think it’s quite a risky set up, so think hard before pursuing something like this!
Home Equity Loan vs Home Equity Line of Credit (HELOC)
If you are considering a home equity loan, you may be weighing the options between a loan or a line of credit. Depending on the lender, the details will be different. Be cautious of whom you are borrowing the money from and carefully peruse the details of any loan, but be especially careful of any loan that takes your home as collateral.
There are some general differences between home equity loans and home equity lines of credit:
- A closed-end home equity loan may be right for you if you need the money all at once. If you need to replace the roof, build a garage or consolidate other debt, then a loan with a one time disbursement may be the answer. The interest rate may be fixed, as are the monthly payments: this may afford you the simplest way to manage your budget.
- A home equity line of credit (also referred to as an open end home equity loan) may be the solution if you need money disbursed at various intervals. This could be the case if you are renovating your house over the period of a year or more, and you are paying different contractors or home improvement stores as you need supplies. Perhaps you are using your home equity line of credit to help a child attend college. Tuition, rent, books and monthly expenses will differ from month to month so a HELOC may be the best fit for you. The HELOC operates similarly to other lines of credit: the interest rate will likely be variable. Your payments may be interest only and will of course, depend on the amount of money you’ve borrowed.
The Scoop On Home Equity Loan Rates and Fees
There will undoubtedly be numerous fees attached to any home equity loan. Make sure that you have comparison shopped between lenders and that you have checked into the fees and rates you are being charged, for they vary from lender to lender. Some fees and rates you will want to check into:
- Annual Percentage Rate: the cost of credit expressed as a yearly rate, including interest and other credit costs.
- Will the interest rate change? What are the terms: is it fixed or variable?
- Application or loan processing fee.
- Appraisal fee.
- Surveyor and conveyor fees or valuation fees.
- Document preparation or loan processing fees: are you entitled to refunds of your application fees if you don’t receive the loan?
- Broker fees: how is the broker to be paid?
- Is there a balloon payment? This is a large payment due at the end of the term.
- Are you allowed to make additional payments, and are there penalties for early payoff?
- Have you been quoted on insurance? Is it necessary or optional?
- What are the total closing costs of the loan?
Most loans will have fees attached to them, but when your home is being used as collateral, there are additional fees and charges. So read the details, ask lots of questions and evaluate potential lenders to ensure that you are not paying more than necessary in fees.