A home equity loan, also known as an equity loan or a second mortgage is a multi-purpose loan where the homeowner uses the equity in their home to borrow money. The equity is based on the difference between the fair market value of the home and total of the loans owed against the home. Home Equity loans became very popular in the mid 90’s as a result of tax changes where certain deductions for interest paid on most consumer purchases were eliminated. Currently, homeowners may borrow up to 100% of the available equity in their homes as well as deduct the interest from their tax returns. Home Equity loans are often used to pay for a variety of purposes, such as:
· Home repairs and improvement projects
· College education
· Family vacation
· Debt consolidation
· Medical Needs
Types of Home Equity Loans
There are two types of home equity loans – a fixed-rate loan and a home equity line of credit (HELOC). Terms for either type can range from five to 15 years.
Fixed Rate Loan - A fixed rate home equity loan, (also called a standard home equity loan, a closed-end loan or a second mortgage installment loan), works like an auto loan. You receive a lump sum payment at a fixed interest rate and you pay the money back in monthly payments over the life of the loan. Since the interest rate on the loan is fixed, your monthly payments will also be fixed. The payment and interest rate remain the same over the lifetime of the loan. This loan must be repaid in full if the home is sold.
Home Equity Line of Credit (HELOC) - A HELOC is a variable-rate loan that works much like a credit card where a preapproved dollar amount is granted to the borrower and can withdrawn using a credit card or checks as needed. The interest rate is generally tied to a market rate, such as Prime Rate. So when the market rates adjust up or down, the interest rate on a HELOC also adjusts. Monthly payments vary based on the amount of money borrowed and the current interest rate. HELOC funds can be borrowed during the "draw period" which is typically 5 years and must be repaid based on a set term. This loan must also be repaid in full if the home is sold.
Home-equity loans make available an easy source of funds. Though the interest rate on a home equity loan is often higher than a first mortgage, it is typically much lower than for credit cards and consumer loans. The interest paid on a home equity loan may be tax deductible as well. As a result, the number one reason consumers borrow against the value of the home using a home equity loan is for debt consolidation. By doing this, the consumer gets a single payment, a lower interest rate and the tax benefits.
Because home equity loans are so easy to get and use, the consumer must be careful not to fall into a perpetual cycle of spending, borrowing, spending and falling deeper into debt. Some consumers get into a habit of taking a loan to pay off another loan which frees up additional credit which the consumer then uses to purchase more stuff.
Is a Home Equity Loan Right for you?
Home-equity loans can be valuable tools for conscientious borrowers. If you have gainful employment and/or a steady and reliable source of income and the payments and terms fit your financial plan, a home equity might be right for you. Review the terms and conditions of the loan and make sure you comprehend the terms and your financial position. Home equity loans should not be used for everyday expenses. Make sure the loan can assist as part of your financial future plan.
If you have more questions or need assistance in determining whether or not a home equity loan is for you, please call the GHS Loan Department at (607) 723-7962. They will help you decide if a home equity loan is right for and which type of home equity is a better fit for your financial situation.