Home equity loan - what is it?
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What is a home equity loan? It is a loan secured on your home. In other words, you give your home as a collateral against the loan.
Characteristics of a home equity loan: |
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(a) |
How much can you borrow against your home? The amount of the loan is usually no more than 80% of the available equity you have in your home.
What is the available equity you have in your home? The available equity is the difference between the fair market value of your home and your outstanding mortgage.
For example, you bought your house 10 years ago that cost you $120,000, and you borrowed from the bank $100,000 to finance it. Because of the rising property prices over the last 10 years, let’s say your house now is worth $200,000, and the outstanding mortgage you owe is $30,000 (ie you have repaid $70,000 over the last 10 years). To determine your available equity in your home, you need only these 2 relevant figures:
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your home's market value = $200,000
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your outstanding mortgage = $30,000
Your available equity in your home = $200,000 - $30,000 = $170,000.
If the lender lends only 80%, the maximum amount of your home equity loan = 80% x available equity = 80% x $170,000 = $136,000. |
| (b) |
A home equity loan is still sometimes referred to as a second mortgage. In the example in paragraph (a), your first mortgage is your outstanding mortgage of $30,000. |
| (c) |
Equity loan rates of interest may be fixed, variable, or a combination of both.
A home equity loan is a fixed-interest-rate term loan. It is repaid usually through monthly instalments.
Since home equity loans are secured against the available equity of the borrowers' homes, they are relatively low-risk to the lenders. Less risk means less cost to the lenders. Therefore home equity loan rates of interest are usually lower than for other loans, such as credit cards and auto loans. |
| (d) |
When an equity loan rate of interest is variable, the equity loan is commonly known as a home equity line of credit (HELOC).
An equity line of credit is not a term loan, and therefore does not impose fixed repayment instalments.
It is similar to a credit card in that it has an approved limit of loan granted to the borrower, but the borrower can utilize any amount of the loan within the approved limit. By contrast, in the case of a home equity loan, the full amount of the loan is given to the borrower in a single disbursement. Thus, an equity line of credit has some flexibility, which makes it more attractive than a home equity loan to some borrowers.
Click here for a more detailed discussion of an equity line of credit. |
| (e) |
An equity loan may also have a combination of a fixed and variable rate, as is already mentioned. |
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