Home Equity Loans, also known as HEL have gained a lot of popularity in the past few years. These home equity mortgage loans are a good way to fund expenses such as improvements and repairs around the house or unexpected bills or even higher education. Home equity loans are often a second mortgage on your property and consequentially reduce the equity component in your house. HEL’s in addition also create a second lien/charge on your property. One must however remember that in order to be considered for a home equity loan it is a given that the consumer must have good to excellent credit history.
Equity Home Loan Information: How Does It Work
Take a look at the diagram above. In this scenario when the home equity mortage loan was taken out, the entire house was valued at $500,000. The consumer contributed $100,000 towards the purchase of the property and borrowed the remaining $400,000. Now let us take a look at the value of the property value and the loan situation after 5 years: 
In this case after valuing the property after 5 years the value has increased to $750,000 thereby giving the consumer equity in the property of $350,000. The client can borrow against this equity. Once the client approaches a bank or a lender, the lender will value the equity property and will calculate the equity the client has in his/her property in the same way will lend funds against that amount. This new lend will create a second or a third mortgage on the property as the case may be. It must however be remembered that equity in a property is not always positive. It can in a lot of cases during a market downturn as we have just experienced, be negative. Consider the above example, if after valuing the property after 5 years, the value had fallen to $350,000 from $500,000, the client would have negative equity in the property of (350,000-400,000 = – $50,000) negative $50,000.
Equity Home Loans Types
Home Equity Loans can be of two types:
- Open End Home Equity Loan: In this type of a home equity loan the lender creates a line of credit (revolving credit) for the consumer and the client can borrow as much as is required and when required. The interest on this charged only on the used amount of the line of credit.
- Closed End Home Equity Loan: In a closed end home equity loan the lender gives the client an entire lump sum amount. The interest is fixed on these loans and they can be amortized over 15 years over the life of the loan.
Advantages of Equity Loans
Some of the advantages of home equity loans are:
- One of the main advantages of a home equity loan is that the loan amount can be used for any purpose as deemed fit for the client.
- Another advantage of HELs is that the interest component of the home equity mortgage loan can be tax deductible based on which tax bracket you fall under and also the purpose of the loan.
- In addition to this depending on whether or not you have a Line of Credit as your home equity loan, you can draw the funds as and when required.
Disadvantages Of Equity Loans
While home equity loans come with a host of plus points, there are some disadvantages worth considering as well.
- The primary disadvantage of a home equity loan is that it increases the repayments on your home loan and can place your mortgage account in danger of arrears and consequently of a foreclosure.
- Another disadvantage may be the fact that with the increased repayments you may disadvantage yourself from being able to borrow in the future owing to reduced servicing capacity. Increased payments may also cause you to miss payments and therefore affect your FICO score.
- In a lot of cases during market downturns you could actually end up owing money rather than having equity in your house owing to the fact that your property was undervalued due to existing market conditions.
As with any loan it is always prudent to take into consideration your financial position. While home equity loans have a lot of advantages, they also have certain disadvantages. It is essential to weigh both pros and cons prior to making a decision regarding the same. Before making a decision on whether or not to get a home equity consider your long and short term financial goals and its possible consequences.
Reference:
- What Home Equity Debt Is – Bank Rate