The Basics of a Home Equity Credit Line
A home equity loan is a loan that uses your home as collateral. Your home equity is the part of your home that you actually own and this is the guarantee for your loan.
Your home equity is calculated by taking the current value of your home and subtracting your mortgage. For example, if your home is worth $150, 000 and you have a $100,000 mortgage, you have $50,000 of equity in your home. A home equity loan allows you to borrow money using your equity of $50,000 as security for the loan.
A home equity loan, often called a second mortgage, reduces your equity or ownership in your home. Since your home guarantees your loan, if you default on the payments, you can lose your home.
Types Home Equity Loans
There are two basic types of home equity loans: the standard home equity loan and a home equity line of credit. Another way of borrowing against home equity is cash-out refinancing.
The Standard Home Equity
Loan A standard home equity loan, (also called a term loan, a closed-end loan or a second mortgage installment loan), works like a traditional 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. An example of this is a home equity loan for $30,000 with an interest rate of 7.5% where you pay the money back in monthly payments of $356.11 over the 10 year life of the loan.
Home Equity Line of Credit
A home equity line of credit works like any other line of credit. You are granted an amount you can borrow and you draw money from the account as you need it. You pay interest on only the amount actually borrowed and the interest rate is variable over the life of the loan. While most home equity lines of credit have a variable interest rate, a fixed interest rate can sometimes be negotiated. A home equity line of credit is 'revolving' meaning that you can borrow money, pay off the borrowed money and then re-borrow that money. The money in a home equity line of credit is accessed using specially issued checks or credit cards.
Cash-out Refinancing
While cash out refinancing is not a type of home equity loan, it does allow you to borrow against the equity in your home. In cash out refinancing you take out a new mortgage that is greater than what you owe on your current mortgage - you pay off your current mortgage and use the difference as a home equity loan.
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