Home equity is the difference of the market value in a property and the mortgage balance. In order to obtain a home equity loan or line of credit, a lender wants to know that a borrower has at least 20 percent equity built up in a home. The home equity loan is a figure based on an appraisal from the bank to assess the value of a property and advance the homeowner the value of the equity. This results in a secondary note on the home-otherwise known as a second mortgage-pledging the property as collateral in the event of default. There are two different types of home equity loans available.
-Home Equity Loan or Cash Out Refinance-
In the scenario of a home equity loan, a property owner contacts a mortgage company and requests an application for a home equity loan. The purpose of the loan is to obtain a one-time lump sum payment direct to the borrower, equal to the amount of his equity. The process is straightforward: the owner fills out an application, the lender orders an appraisal and the loan is closed in 30 days, at which time the borrower receives his payment. The payment can be used for a variety of large expenses such as home improvement, college tuition or other major purposes. The purpose of the home equity loan is of no consequence to the lender as long as the borrower repays it according to the terms of the loan.
In this scenario, a home equity loan takes 10 to 20 years to payoff and carries a higher rate of interest than the first mortgage. The homeowner is responsible for making equal monthly mortgage payments on the first mortgage and an additional payment on the second mortgage until both are paid off. Should the homeowner default on either the first or second mortgage, he can face foreclosure.
-Home Equity Line of Credit-
The process for obtaining a line of credit is almost identical to a home equity loan or cash out refinance. The difference between these options is the accessibility to the funds being more than a one-time payment. A home equity line of credit gives the customer access to the equity funds granted at the time of the loan closing on a revolving basis.
For example, if a homeowner receives a $30,000 home equity line of credit, he can use this sum on a flexible spending basis. If he opts to use $10,000 of the $30,000, he has the option to use the remaining balance at any time in the future. Subsequently as the owner pays down the balance of the loan, the credit limit rises to the initial $30,000 mark. A home equity line of credit works similarly to a credit card but carries a lower interest rate in comparison to its plastic counterparts.
Regardless of the equity option a homeowner selects, it is vital to remember that the property is the collateral for the loan, and both result in an additional monthly payment obligation on behalf of the borrower. Even when the first mortgage is paid in full, the obligation to the home equity loan lingers until paid. Before applying for a home equity loan or line of credit, seek counsel from a financial planner or personal accountant to assess the impact on a monthly budget.