Home equity loans are one of the many different credit products offered by lenders around the country. For those who don’t know, a home equity loan is a line of credit which is backed by the borrower’s home. The lender considers the current market value of the home and generally offers to finance up to a certain amount of that value, we’ll say 80% for this discussion. On a $100,000 home, a loan against 80% of the value would equal $80,000. The lender subtracts what is still owed on the mortgage, and what’s left is the amount of credit the homeowner qualifies for.
In most cases, a home equity loan can be used for just about anything because the borrower’s house is the collateral. It is revolving credit, which is to say it’s used like a credit card. The borrower doesn’t get a lump sum at the start of the loan period. Instead he gets access to the funds as he needs it, making monthly payments on the outstanding balance. These loans usually have very favorable interest rates and terms, but that’s not a guarantee. If a borrower has poor credit history, a lot of outstanding debt, or limited income, a lender might set a lower credit limit, a higher interest rate, or a combination of both.
Most home equity lines of credit have a limited term, say 10 or 15 years. How the term is dealt with varies from lender to lender. In some cases the loan expires at the end of the term and the borrower can spend nothing more on it. In other cases the borrower will have the option to renew with everything continuing on unchanged. Sometimes the term of the loan has a hidden trap that hurts many homeowners; the payment clause. With these home equity loans there is a requirement to pay the outstanding balance at the end of the term. It’s not uncommon for a borrower to see the end of his equity line looming on the horizon while he expects to be able to continue paying on it after the expiration. Imagine the surprise when the bank sends the bill for the entire outstanding balance. The possibility of losing your home due to default is the one factor that makes these loans something to seriously think about.
If you are shopping for a home equity line of credit, make sure you compare what each lender is offering. Look at the percentage of your home’s value they are willing to loan against, what the interest rate a term length will be, and what happens at the expiration of the term. Also check with the lender to see if there’s any possibility your loan could be sold to another company. And finally, remember that any source of credit brings with it the responsibility of making good on your debts. Defaulting on loans raises the cost of banking for all of us and hurts the lenders who make the loans.
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