What is a Home Equity Loan?

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A home-equity loan is a type of loan, often referred to as a second mortgage. This type of loan is based on the value of a home today, vs. what it was worth when the original purchased was made or mortgage approved.

Homes normally appreciate. That is a gain in value. Thus the increase in the value of the home from the time it was purchased, to the time the home-equity loan is secured, represents the increased value of the house. Thus a home-equity loan is a loan made against the increased value of the home. It does not lower the mortgage if it still exists. It will provide the basis for a second mortgage or loan based on the amount between the original price and the current market price. That number is referred to as the equity a person might have in the home.

Home-equity loans are generally treated the same as a mortgage. However, they can be treated as a line of credit, where the person takes only what is needed when it is needed. This can result in some saving regarding interest and the total amount of the loan. The home equity line of credit may be easier to get, but it has many of the impacts that come with a home equity loans. Also, interest rates may be higher, depending upon the area and the lender. The person’s credit rating has to be checked. The home has to be inspected, and the family income will have to be examined to make certain they are able to afford a second monthly payment in addition to the payment for the original mortgage.

People secure home-equity loans for a number of reasons. A common reason is to make improvements to the home by adding a room, updating the kitchen or bathrooms, repainting or adding siding and landscaping. Thus, by doing this, the home-equity loan is being used to add more value to the home. This makes it more attractive to would-be buyers in the future. Sometimes, home-equity loans are used for other purposes, depending on the amount of equity in the home and the remainder due on the original mortgage. These funds can be used to cover the cost of unexpected bills, damage that was not covered by homeowner’s or flood insurance, to help pay college expenses for children or even to start a new business.

If the equity is enough and interest rates are at a reasonable level, some people will take the home-equity loan and then refinance the total mortgage, depending in interest rates and the family’s ability to repay the high loan.

Securing a home-equity loan is much like securing the original mortgage on the home. As noted the institution making the loan, a bank or a home financing company is going to want to inspect the building, just as was done when the original purchased was made. This will include a general inspecting, plumbing, electrical, termite inspection and roof inspections, which are expenses that the borrower will have to incur. An appraisal of the home will have to be made to see how its value compares to the value of other homes in the vicinity.

While most homes do appreciate in value, meaning they are worth more than when originally purchased, others will depreciate in value because of changes in the neighborhood, nearby zoning changes or failure to maintain the home in a proper fashion. If the home has deceased in value, the likelihood of securing the home-equity loan becomes more difficult if not impossible.
When a loan is approved, it becomes a lien against the value of the home. Thus, if the owner wishes to sell the home, he will have to secure a price that will pay off the original mortgage and the secondary home-equity loan.

If a person seeks to refinance his home to take advantages of lower interest rates or better terms, the home-equity loan is usually rolled into the new mortgage, though there are exceptions to this practice that are at the discretion of the company in handling, the refinancing of the building.

The decision to secure a home-equity loan should be given a lot of considerations. It will allow the opportunity to increase the value of the home. However, the owner has to consider whether the improvements planned will add to the retail value of the home. Adding a bedroom or another bathroom will usually increase the value, Installing new wallpaper and painting all the wall paper may make the home less appealing to potential buyers in the future. Finally, the proceeds from a home-equity loan must be spent in a prudent manner. When the loan is approved, and you are handed a check, there may be an inclination to purchase a new car, to eat out more often and do other things that will not enhance the value of the home.

If this happens, and it becomes necessary to sell the home because of a job transfer, illness in the family or other reasons, the owner may find some roadblocks. It is possible the value of the house has not risen enough to pay off the original mortgage and the home-equity loan. Thus, the owner is forced to sell the home at a lesser value and to cover the remaining amount owed to the bank or mortgage company with his own funds. A home-equity loan can be a wise financial move, especially if neighboring houses have updated and the neighborhood has become popular with new families wanting to move into the area.

Therefore, it is necessary that the home-equity loan be used to improve the home and not used for other activities. If improvements to the home are planned they should be akin to other improvements made in the areas.
If the funds are going to be used to finance college educations or other like matters, it must be accepted that the future sale of the home may be more difficult because it has not kept up with the trends that have taken place in the local community.

Your lender will question you about the improvements you want to make and the amount of loan you are seeking and will then advise you on how these actions will affect the future value of the home, if the time comes when you want to or must sell it for one reasons or another. Know the value of your home. Understand how much you still owe and decide how the home-equity loan is going to be used. This will help you to make the best decision.

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Written by Brian McCaw

Brian is a lover of all things real estate including photography, architecture, news, and so much more.