What you need to know about home equity loans

Do you have a renovation that you are looking to do? Or maybe there’s some other sort of expense that you are looking to cover? Here’s what you need to know about home equity loans.

What is a home equity loan?

A home equity loan is a loan that involves a lien on your property. You use the equity in your home as collateral and borrow against it. The amount that you can borrow depends upon how much equity you have in your home.

A home equity loan is sometimes called a second mortgage. It’s a loan for a lump sum and typically has a fixed interest rate with a term generally shorter than a 30-year mortgage. Sometimes home equity loans can have adjustable rates.

Who can qualify for a home equity loan?

To get a home equity loan, you would need to have at least 20% of your home value in home equity. Your property would be appraised, and you’d need to have good credit so that the bank knows that you can repay the loan. Your income and debts will be analyzed to make sure that you can pay your home equity loan along with your mortgage.

How do you pay back a home equity loan?

A home equity loan is like a regular mortgage where you have an interest rate, and the loan is amortized, which means that you pay a portion of your payment to interest and a portion to principal. Also, the proportion of interest to principal payments is higher in the beginning than towards the end of the mortgage. If you have a fixed rate loan, the payment will always stay the same. If it is an adjustable rate loan, your payments may increase (or decrease) over time.

Why do people typically get home equity loans?

Home equity loans can be attractive for people who need to pay for something with a fixed value, such as a renovation, education expense, or a large medical bill.

What happens if you can’t pay back your home equity loan?

Because a home equity puts a lien on your property, by not paying your loan, a bank has a legal right to foreclose and then the proceeds from the home sale are used to pay off the loan balance. If you are 30 days late, you are considered in default. State laws determine when your lender can begin foreclosure proceedings.

If your home is foreclosed on, the bank that has your first mortgage will get paid back first, and the bank that has your home equity loan will get paid back second (assuming they are different banks).

Your best bet is to try to negotiate with the bank that has your HELOC to try to reduce rates or payments. The best time to do this is before you miss a payment, or at the latest, shortly after. The lender for your home equity loan is second in line to get paid by a sale of your home (after the bank that holds your first mortgage), and they may look for ways to resolve delinquencies without forcing the sale of your home.

What sort of consumer protections are there around home equity loans?

The federal Truth in Lending Act requires lenders to disclose the details of your home equity loan, including interest, charges, payment terms and adjustments, if any. You should be given this information when you apply for the loan, and get more disclosures before the credit line is finalized.

The Truth in Lending Act gives you three days from when you sign the paperwork to cancel the loan for any reason and be refunded all of your fees, no questions asked. Simply inform the lender in writing.

Should you get a home equity loan?

First and foremost, you want to make sure that you understand the terms of the loan, and make sure to shop around to different banks and compare deals. There are many different types of home equity loans with different terms.

Because the loan is secured by your home, you want to make sure that the amount that you are borrowing and the payment amounts are low enough that you won’t have a risk of default, as it can force the sale of your home.

Do you want to learn more about how to make your home a financial success, no matter kind of loan you get (or don’t get)? Read about our new book: The Game Plan for Homeowners: Control your Destiny and Win Big While Avoiding the Traps. It’s available now in both digital and print copies and takes you through everything you need to know about making your home a financial success in the short and long term, without getting taken advantage of.

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