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Home Equity Loan or Credit Line

A home equity loan, often referred to as a home equity credit line or home equity line of credit (HELOC), is a type of loan which enables you to borrow money, based upon the value of your home, using your home to secure the loan. To obtain a home equity loan or home equity line of credit, you must pledge your home to the lender, just as you do for a home mortgage. This pledge is your assurance to the lender that you will repay the loan. Essentially, the lender has become a partner with you in the ownership of your home.

Once you have entered into a home equity loan or home equity line of credit agreement with a lender, your home serves as collateral to protect the lender from the possibility that you may not pay off your debt as promised. If you fail to meet your obligation under the terms of the loan agreement, the lender can seize your home and sell it to recover the money you owe, a process known as foreclosure. A home equity lender or mortgage lender also has the right to periodically inspect the condition of your home to insure that their investment is being properly maintained so that it does not lose its value.

A home equity loan or home equity credit line is considered to be a second mortgage when it is entered into while your primary home equity mortgage is in place, borrowing upon the equity or value not already borrowed upon by the primary home equity mortgage.

Some home equity loans, such as home improvement loans or debt consolidation loans, may stipulate how the loaned money is to be used by the homeowner. Other types of home equity lines of credit come without such restrictions. Conditions of this sort may be directly related to the borrower’s credit history.

A standard home equity loan provides the entire loaned amount of money up front (at the time the loan agreement is signed) minus fees assessed by the lender, such as points, which represent an amount based upon the amount of the loan, and fixed fees as well as funds earmarked in the loan agreement to pay off existing debts. You will then be required to make monthly payments, portions of which will be allocated by the lender to both interest payments and repayment of principal in accordance with the terms of your loan agreement.

A home equity line of credit permits a homeowner to borrow up to a maximum amount on a gradual basis as the need arises. Such a line of credit will often be presented by the lender in the form of a checking account or credit card, thereby enabling easy access to the borrower. An advantage of this form of home equity loan is that you can borrow upon the line of credit on your schedule, thereby resulting in smaller interest payments if you do not require the entire amount at once or if your needs change. A disadvantage is that you may pay higher up-front fees or recurring service charges for the flexibility such a line of credit offers. For these reasons, it is extremely important that you determine before entering into a home equity loan agreement exactly what type of home equity loan best suits your needs.

IMPORTANT! Always ask what the margin is on a home equity line of credit. A high margin, which is rarely disclosed, can result in a substantially higher interest rate than you were expecting! Read How Do You Shop For a HELOC? by Dr. Jack Guttentag.

Authored by Kenneth L. Anderson.  Original article published 22 February 2006.

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