Home Equity Loan: What Exactly Is It?

Posted by Nick Niesen on October 29th, 2010

As a homeowner, you must have been deluged with offers for a home equity loan. Don't know what this is? Don't worry, you are not the only home owner out there that has had to stop and ask exactly what a home equity loan is.

These loans have actually become more common over the last 20 years or so. .

Understanding the Home Equity Loan

There is equity locked in your owned house. A home equity loan allows you to unlock that equity. Another way to look at it is that the homeowner uses the equity in his or her home as collateral. These loans are often taken out by homeowners that need to finance home repairs or remodeling, pay for unexpected medical bills, or even to pay for higher education.

Basically what this type of loan does is create a lien against the home and until it is paid off the actual equity in the home is reduced by the loan amount.

Let me not mislead you into believing that absolutely all homeowners can get a home equity loan. These loans are reserved for those that are and have been in good standing with their mortgage company and also have excellent credit histories. The home equity loan is essentially a second mortgage because they are secured with the value of the home just as a first mortgage is.

Thirty year first mortgages are popular. But home equity loans tend to be of shorter duration.

There is more than one type loan on your home's equity: open end home equity loans and closed end home equity loans. Open end home equity loans are those that are referred to as a line of credit. With this type of loan the borrower can determine when and how they would like to borrow against the equity in the home.

These loans usually allow for the borrower to borrow 100% of the value of the home and can be made available for up to 30 years with a variable interest rate.

In a close-ended loan type, a fixed some of money is actually given to the borrower and that concludes the transaction. The amount that is given is figured by determining the value of the home, the income of the borrower, as well as the credit history. Given that the money is given in one shot, close ended lenders prefer a fixed rate of interest.

As a home owner, a loan on the equity of your home is your prerogative. Many times homeowners are able to secure a better interest rate on this type of loan than they are on a personal loan, making this a more affordable loan option. A loan is not free money. That much is obvious. So make sure that you compare all options before choosing one.

Ultimately, a loan, of any kind can be a double edged sword. You can gain from it, or suffer because of it. Your prudence and maturity will decide whether the loan was a good idea.

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Nick Niesen

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Nick Niesen
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