Homeowners can leverage the equity built in their home without selling the property. Those with immediate cash needs can take out a home loan to help pay for medical bills, renovations, or other expenses that require immediate funds.
How Home Equity Loans Work
An equity loan differs from the closely related home equity line of credit. A house loan is for a set amount of money, with a repayment schedule and a fixed interest rate. A home equity line of credit is a revolving account with a borrowing limit, and a monthly repayment depending on the amount of credit issued at the time.
A home loan can be a smart choice when a large sum of money is needed for a one-time payment, while a line of credit is more appropriate for ongoing cash needs.
How To Borrow Money Using a Home Equity Loan
Lenders are more likely to approve a home loan than an unsecured loan. If the borrower defaults on the loan, the property is repossessed. Using the family home as collateral makes the borrower more attractive as a home loan candidate, but it carries a degree of risk. Use house loans for necessary expenses, not luxuries such as vacations or expensive vehicles.
In their Home Equity Lending Survey Report, the American Banker’s Association notes that banks average a 1.25% return on assets when issuing home equity loans, compared to a 1% return on all products. Simply put, banks find house loans attractive because they make more money, with less risk.
Approach the lender with a request for the amount of money required, but beware the amount offered. Some lenders offer loans of up to 125% of the value of the equity in the home. This puts the borrower in a position of owing more on the house than it is actually worth. Borrow only the amount needed for the project or expense at hand.
Using a House Loan to Consolidate Other Debts
Home loan interest rates are far lower than the rates paid on credit cards or unsecured lines of credit. An equity loan is one option for consumers in need of debt consolidation. A home equity loan with a term of 5 to 15 years can allow the borrower to pay off consumer debt at once, then pay back into the home loan a predetermined monthly amount.
The advantages of this consolidation strategy include a lower interest rate, one payment rather than several to different lenders, and the peace of mind in knowing the debt repayment amount each month.
Beware Home Equity Loan Scams
In this March 16, 1998 press release, the Federal Trade Commission identified several unethical and abusive lending practices. Among them:
- Equity stripping- the lender considers only the value of the home, and not the borrower’s ability to repay the loan. Unethical lenders may offer the loan to individuals lacking the income to repay the money so they can seize the property when the borrower defaults.
- Packing- this is the practice of tacking additional investment or insurance products onto the loan, to increase the lender’s profits.
- Flipping- the lender entices the borrower into refinancing several times in a short period, to repeatedly profit from high fees.
Avoid lenders who try to engage in these practices. Always seek the advice of a qualified lending professional before refinancing or taking out a home equity loan.