Home Equity Loans: The Facts

Home equity loans have been given a lot of attention since 2000. People have been cashing out the equity in their homes to pay off credit card debt, to make home improvements, and to pay for other miscellaneous expenses. Everyday there are dozens of commercials that promote companies that offer home equity loans and debt consolidation loans to home owners. Before you try to use the equity in your home to finance a project or pay you're your credit cards you need to understand the basics facts about home equity loans.

Types of Home Equity Loans

There are two main categories of home equity loans. The first category is the closed end home equity loan. A closed end home equity loan offers borrowers a lump sum distribution of the loan funds amortized over a period of about 15 years in most cases. Closed end home equity loans are called 2nd mortgages or debt consolidation loans and they are secured by the person's home. These loans typically charge a higher interest rate than first mortgages do, however, people can usually deduct this interest from their income taxes.
 
The second type of home equity loan is the open end loan. The most common open end home equity loan is the HELOC, home equity line of credit. This loan is a form of revolving credit that is guaranteed by the person's home. The lender offers the borrower a line of credit that the borrower can draw against during the term of the loan. The minimum monthly payments that are due are usually interest only payments. The borrower then has the option to pay down the principal borrowed as well; however, they get to select how much of the principal they pay back and when. When the HELOC expires the borrower either has to refinance their loan or they will need to payoff the remaining balance on the loan in one lump sum.

Qualifying for a Home Equity Loan

There are many different home equity loan programs that you can apply for. Most will be designed for people who have a good to excellent credit rating. Other factors that will be taken into consideration will be your payment history, the value of your home, how much you still owe on your home, and your employment history. If you have less than perfect credit you can still qualify for special bad credit home equity loans. To qualify for these home equity loans you will still need to meet minimum credit score standards, you will need to be able to pay the monthly minimum payments for the loan, and you may need to get a co-signer in order to qualify.

Fees and Interest

Like any other type of mortgage, home equity loans have several costs that are associated with them. The largest expense will be the interest rate. Home equity loans tend to have much higher interest rates than first mortgages do. You should expect to pay an interest rate that is at least 2 points higher than your first mortgage, depending on what the current prime rate is. Also, if you are applying for a bad credit home equity loan or debt consolidation loan then you should expect a substantially higher interest rate. You can sometimes lower your interest rate by paying points up front. While this will increase your closing costs it can end up saving you a lot of money over the term of your loan.

In addition to interest you should also be prepared to pay closing fees, processing fees, and maintenance fees on your home equity loan. Some of the fees that you may be charged include: lender fees, title fees, stamp duties, courier fees, appraisal fees, payment processing fees, and other closing fees. If you are planning on either refinancing your home or paying off your home equity loan early then you want to make sure that your loan does not have an early pay off fee.