How Does a Home Equity Loan Work

With home equity loans now advertised on media sources exposed to us from all angles, there’s no doubt you’ve come across the term at one point or another.  But do you understand what the term home equity loan really encompasses?

In its simplest form, a home equity loan allows homeowners to get a loan secured by the equity value of their current home.  Once equity has been accumulated in a home, the homeowner is eligible to apply for a home equity loan on that property.  The equity in a home is what remains after you subtract the amount owed on the mortgage from the present market value of the home.  Home equity loans are especially useful to pay for large one-time expenses, such as medical expenses, home improvement projects, and recreational trips.  Home equity loans are also often used to pay off credit card debt, college loans, and other types of outstanding debt. 

Rates and Fees are Critical

There are various terms and conditions associated with home equity loans that you should understand; but the interest rates charged on your loan are of critical importance.  Obviously, your objective in the loan application process is to obtain the best deal possible on your home equity loan with the lowest rates and fees.  The interest rate charged on your home equity loan is critical because it can either save you thousands of dollars or cost you thousands of dollars.  There are two categories of factors that can affect the interest rates charged on your loan.  These factors are known as internal factors and external factors.  The internal factors that affect interest charged on your loan include the amount of the loan, the length of the loan, and your credit worthiness.  Some of the most important external factors include current economic conditions, inflation/deflation, and present demand for home equity loans. But don’t worry!  There’re ways to go about getting the lowest possible interest rate on your home equity loan. 

Evaluate Your Loan Terms

First, you should evaluate different loan terms to identify any savings that can be realized from loans with different period lengths.  In general, loans with shorter life spans save more money than loans with longer life spans because less interest is paid out over the life of the loan.  Another way homeowners can achieve a lower rate is by paying out a large down payment at the signing of the loan.  This decreases your monthly payments and, consequently, lowers the overall interest expense charged on your loan.  Finally, a good credit score can always bring you out ahead when applying for a loan.  A good credit history and good credit score tells your lender that you are a financially responsible borrower and they often reward you with a lower interest rate in return for your creditworthiness.

Leverage the External Economic Factors

In terms of external factors, you should begin by taking a look at the condition of the home equity loan market as well as the overall health of the economic environment.  If demand for home equity loans is relatively high at present time, then it would be a good time to get a home equity loan.  This is because high demand means lower interest rates.  Another way to ensure low interest rates is to apply for a fixed rate on your loan as opposed to a variable rate.  Although the fixed interest rate may be slightly higher at the signing of the loan, this rate stays the same over the life of the loan.  The variable interest rate can increase at any point during the life of the loan, due to the aforementioned external factors, possibly leaving you unable to meet monthly loan obligations.  Fixed rates satisfy the fact that it is better to be safe than sorry.

Ask Questions – Read the Fine print

Other than mortgage rates, the home equity loan application process involves a variety of terms and conditions that you need to understand before signing the loan agreement.  Be sure to ask your home loan lender as many questions as it takes to fully understand all that is encompassed in the loan agreement.  Read all fine print and never provide your signature before understanding what you are agreeing to.  Once you educate yourself on home equity loans, you should be able to make wise decisions and securely borrow cash through the equity in your home.