The equity you have in your home can be a powerful tool in managing your overall financial situation. Your equity, the value of your home minus your existing mortgage, can serve as collateral for additional borrowing. While there are some risks with this strategy (as with any borrowing), home equity loans offer the attractions of lower rates, convenience, and often tax benefits.
Financial institutions view home equity as good collateral and are often willing to lend you money against that equity. Lenders may issue you a special check or give you a line of credit that you can access as overdraft protection against your checking account. There are usually forms to sign and an approval process that is not too difficult. There may also be some form of commitment fee.
The amount lent to you depends on the amount of equity in your home and your other credit characteristics. A general rule of thumb is all debt including first mortgages, home equity loans, and other loans where your home is pledged as collateral should be less than 80 percent of the current value of your home.
The interest rate charged will usually be variable and will be pegged to a published index, like the prime rate. There are also some institutions that offer low teaser rates initially and then raise the rates after a period. Always check out the rate details, and choose the loan that is right for you. Remember it’s not just the rate that matters, but also your relationship with the financial institution making the loan.
Usually, you repay the loan in regular installments and with minimum repayments required. With some home equity loans, the minimum payment may only be the interest on the loan, and you may be required to repay the loan at a certain date. You need to read the details carefully.
Even though you are borrowing against your house, there is no requirement that the money be used on your house. A home equity loan can be the source of funds for college tuition or even to buy a car. Compare the rates on an auto loan and a home equity loan the next time you are financing a car.
Borrowing against the equity in your home should be considered carefully. Even though there are benefits, these types of loans are like other loans – you pay interest and the loans must be paid off. Most people use home equity loans for conservative purposes and avoid making risky investments or extravagant spending with the proceeds.