How do Home Equity Loans Work

Home equity loans, or HELs, are loans established using the equity of your home as collateral. These are a basic type of secured loan that come with several benefits. There are several elements of the loan that may be unfamiliar to a new borrower that need to be considered.

Like any secured loan, in order to obtain a home equity loan the collateral must have sufficient value to cover the loan amount. The lender will set a guideline for this, typically from the 80%-100% range depending upon credit worthiness. With the sub-prime mortgage crisis many financial institutions have tightened this guideline.

* The benefits

The rate on a home equity loan is typically based upon the bank prime rate. This rate is generally among the lowest rates that a bank will offer, making a home equity loan an attractive alternative to many other loan options.

Home equity loans can be used for any purpose. Although this is a loan based upon the equity of a home the proceeds do not have to be used on the home. These loans are very flexible.

These loans are also tax advantaged, since they may be used for any purpose a home owner may use this loan to purchase something that would otherwise not have a tax deduction. In this way a boat loan, car loan, or even a debt consolidation loan can be a tax write off. Consult a tax advisor to make sure the tax deductibility will apply to any particular situation.

* Considerations

A home equity loan is a type of mortgage. For some, this means very little, for others this carries a stigma. Before signing for an equity loan a borrower should consider that they are putting their home on the line. In the event of default the home may be seized to cover the loan.

A mortgage is also a matter of public record. This means that by taking out a mortgage the lien becomes a searchable document with the state and/or county. Anyone can see that a mortgage exists upon the home.

The lender will have an interest in the home. This means that the lender will require sufficient insurance coverage upon the home to cover the lender’s interest. While it is a good idea to have this coverage even without an equity loan, after acquiring the loan this coverage will become mandatory.

A home equity line is a secured loan that uses the equity in a home as collateral. This type of loan typically has a lower rate than many other loans, is tax advantaged, and places a mortgage lien upon the home. Consider the pros and cons carefully before deciding to take a loan out upon a home, it may be an excellent choice for many, but it is not for all.