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Home Equity Loans

For homeowners who have built up equity in their home, a home equity loan can be an excellent source of financing. Consumers, however, should have a clear understanding of both the benefits and potential risks before signing on the dotted line. Take the time to review the articles in this section and other consumer oriented web sites and, when shopping for that next home equity loan, put yourself in a position to make a decision you can feel secure about.

There are two types of home equity loans, a home equity line of credit (also referred to as a HELOC...pronounced he-lock) and an installment home equity loan. Both loan types are also often referred to as second mortgages. A second mortgage is simply a mortgage that is the 2nd lien on a property, with the existing first mortgage, not surprisingly, being the 1st lien. Let's review the features that distinguish each home equity loan type.

Home equity lines of credit

A home equity line of credit is an open-ended loan, which simply means that you have a set credit limit and the ability to withdraw money at your own discretion. Similar to a credit card, a monthly payment is required only if a balance exists, otherwise there is no monthly payment. To access funds a borrower can simply write a check, or in some cases use a card provided by the lender. This flexibility in a HELOC is attractive to many consumers, as you control how much money is withdrawn, and when. HELOC's also provide an excellent source of emergency funds. As good as this sounds, it does require a heavy dose of fiscal responsibility on the part of the consumer to prevent overuse of the credit line. And unlike a credit card, a HELOC will have a predetermined end date, usually 10 or 20 years. Many home equity line of credit loans are variable rate loans, meaning the payment could change lower or higher. Furthermore, most Lenders reserve the right to lower the credit line limit when home values weaken.

Intallment home equity loan

When you see the term home equity loan, this is referring to an installment home equity loan. Unlike a home equity line of credit, most home equity installment loans are standard, one-time loans that are approved for a given amount and must be repaid over a pre-arranged schedule of installments ranging from three to 30 years. These loans are commonly used for a one-time purchase or as a debt consolidation loan. Some people prefer the peace of mind with a monthly payment that never changes; confident to know that even though it won't go lower, at least it won't rise.

Benefits of taking out a home equity loan

A key motivation for many people who take out either a home equity loan or HELOC is the tax deductibility of the interest. It's always wise to check with your tax advisor, but the fact is that the interest on the majority of all home equity loans or HELOC's is tax deductible. Home equity loans also offer lower interest rates than almost any other type of loan. If you need a fairly large chuck of money, a home equity loan may be your best bet. Need $25,000? You simply won't find a personal loan for that amount. If you have the requisite equity in your home, however, most lenders will gladly take a look at your situation.

Risks associated with home equity loans

All home equity loans are secured by your home, therefore several important factors need to be considered. Any lender that holds a mortgage on your property, whether it's a first mortgage or second mortgage, has the right to initiate foreclosure when payments fall delinquent. When entering into a home equity loan commitment you should ensure that emergency funds are set aside in case of a drop in your income. Any respected lender uses foreclosure as an absolute last resort, as they normally lose money in this process. However, savvy consumers should err on the side of safety. Know your finances and have a backup plan in place. In addition, homeowners should always be aware of prepayment penalties. Prepayment penalties make refinancing costlier if not prohibitive. Another factor to consider is that any home equity loan would have to be paid off in the event you are going to sell your home.

Historical note

The credit market crisis that started in 2007 has drastically altered the mortgage lending environment. Prior to this period lenders typically offered a vast array of mortgage products, with customers of every conceivable credit background stepping up to the lending trough. Adjustable rate mortgages proliferated, it was common to see ads for "no documentation" loans, and lenders gleefully approved loan after loan. Consumers with bad credit had relative success in getting a home equity loan. Those days are long gone. Many experts suggest for a long, long time. This is largely viewed as a positive economic development for the long run. Lenders, hopefully, have learned their lesson to return to a sensible risk based approach to lending. In the short term, of course, problems abound. Home values have plummeted, and lenders, in many cases, have stringently tightened their lending guidelines. What this means for the average consumer is that it will be even more critical to acquire the know-how to learn how home equity loans work, and become a confident and wise loan shopper.