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Home Equity Loans

Many people borrow against their established home equity to be able to use the money for home improvements, paying medical bills, for investments in their business ventures or for college education for their children. A Second Mortgage can help achieve these goals.

A second mortgage involves borrowing against the equity you have already built up in your property. Second mortgages are subordinate to a first mortgage and are considered riskier for lenders. In case the loan goes into default, your first mortgage has priority and gets paid off first before the second mortgage. As a result, second mortgages typically have higher interest rates and a shorter term.

More often than not, when we speak of a second mortgage, we mean a Home Equity Loan, an additional loan secured against the property. By definition, a Home Equity Loan (HEL) is a secured loan type in which the borrower uses the equity in his/her home as collateral. A home equity loan creates a lien against the borrower's house. You may be able to borrow almost the full amount of your equity, but remember that it's your home that you put in pledge.

It is essential to seek financial advice from a professional before securing any type of home equity loan, since in case you fail to repay the amount borrowed or refinance the loan, you risk losing your home. Missing or being late on loan payments can lead to foreclosure within 60 to 90 days. Therefore, your intended use of funds must be well worth taking such a risk.

Home Equity Loans come in two types: closed end and open end. The actual choice between the two types will largely depend on your particular situation. You should determine the amount of money you need, how long you will need to pay the loan off and how much you can afford to pay monthly. Having a clear idea of these aspects, you can make the right decision.

The closed-end home equity loan is also called a term loan. It is a traditional home equity loan, which is characterized by a one-time lump sum payment a borrower receives at the time of the closing. No additional amount can be borrowed. In this case interest starts building as soon as the lending institution issues you the money.

Closed-end loans usually have fixed rates, which implies the same loan repayment on a monthly basis. A borrower will have regular payments structured over a period of years until his/her home equity loan is paid in full, usually 10-15 years. The variables determining what amount can be borrowed are an applicant's credit history, the evaluated value of the collateral, income source of the borrower etc. You can borrow up to 100 percent of the appraised value of the home, less any liens.

Some home equity loans offer reduced amortization and a balloon payment becomes due at the end of the term. Paying above the minimum payment or refinancing the loan can help avoid these larger lump-sum payments.

Open-end home equity loan, also referred to as home equity line of credit, is much more flexible than the closed-end type. A bank gives you a credit card to make purchases, which accrue against your home's equity. In this case, interest does not begin building until you start making purchases. Borrowers have an opportunity to choose the time and the borrowing frequency. They are allowed to borrow up to an approved dollar amount for the life of the loan. The lender sets a time limit, within which you can withdraw money whenever you want to use it for your needs. In this aspect, a home equity line of credit can be compared to a credit card. Paying down the balance frees up funds for use, and as soon as you pay off the principal, your credit revolves and you can access it again.

Normally a borrower has between 5 and 20 years to access the credit line, and once this period has expired, he/she must stop borrowing and repay the principal and interest within a period of 10 to 20 years, or pay the principal in one lump payment, i.e. make a balloon payment. The credit interest rate is adjustable and fluctuates depending on the changes of the market.

"Revolving credit" can be very convenient, and if you can repay principal between charges, the line of credit may be more beneficial than the term equity loan for you. However, there are certain aspects about the line of credit that you may regard as its drawbacks, like variable interest rates, or monthly payments based on the interest rate and the amount of credit you have used.

Some home equity line of credit plans may require you to borrow a minimum amount each time you draw on the line or require that you take an initial advance when the line is set up. These minimum draw amounts may exceed your personal needs. It's up to the lender to decide whether they allow you to extend or renew the line of credit when the time limit expires.

To sum it up, the major difference between a closed-end home equity loan and a Home Equity Line of Credit (HELOC) is that the letter involves a line of revolving credit with an adjustable interest rate, while the first is a one time lump-sum loan with a fixed interest rate. If you need a set amount for some specific purpose, you might consider a closed-end home equity loan rather than a home equity line of credit.

Your lending institution will allow you to draw upon a fixed amount of equity. Equity is generally the difference between your home's value and the balance on your mortgage loan. There is a special formula you can use to determine your home equity. You should subtract the amount of the mortgage balance from the current fair market value of your property. Your equity increases as your mortgage balance decreases. If you are one of many homeowners who have liens or second mortgages on their homes, you should subtract those amounts from the appraised value too. Thus, if your home is worth $150,000 and you owe $85,000 on the mortgage, then you have $65,000 of equity in your home.

If you have paid off $40,000 on a first mortgage of $200,000, you can take a second mortgage to borrow against that $40,000. If you have a very good credit or other assets to secure the loan, it may be possible to take a second mortgage for more than you have stored up in equity, e.g. a 125 percent second mortgage. However, you may have to pay higher interest rates with after-tax dollars.

It is also possible to take out a second mortgage at the same time that you purchase your home, or to take out third mortgages. Remember however, that interest rates and penalties will get higher and you will put even more stress on your equity and mortgage. Make sure you analyze your interest rates, consumer debt, long-term financial situation, and equity savings and consider refinancing plans before going with one of these options.

There are several ways in which you can repay a home equity loan. For example, you can make regular payments toward both the interest and the principal. Some loans allow for paying only the interest at the beginning of the loan and then paying more of the principal. If you have checked it with your lender and there are no penalties for paying ahead on your loan, you can opt to pay both principal and interest, making extra payments to pay off the principal sooner.

Make sure you read all the fine print and understand the part concerning the variety of fees. Ask your lender about all possible fees they will charge. The fees may include origination, application, appraisal fees, title fees, stamp duties, and early closure fee.

Note that once you have taken out a second mortgage, it will become increasingly difficult to get any additional financing in case you need more funds for any other reason. Generally, a second mortgage means more debt, more interest due, and more time it takes to pay off your mortgage.

Home equity loans are appropriate when you need to cover a large expense or consolidate consumer debt. By borrowing against your home, you can get bigger loans. The interest on most home equity loans is tax deductible, which adds to making such loans an appealing option when you need to make a major purchase.

To qualify for a second mortgage, a homeowner will need high credit score, valid employment history, substantial equity in the first mortgage, and low debt-to-income ratio.

Shop for a second mortgage with your bank or credit union, or try to get it from the lender that has your primary mortgage. Check a variety of sources including brokers to get the best loan. With home equity loans, you have plenty of programs to choose from. Depending on your particular situation, consider which option will suit better, adjustable or fixed-rate. Plan out your budget, manage your credit score and keep your credit reports accurate. Make sure the deal you have chosen will work in your best interest. For example, if you are not sure whether you want to put your home at risk, find out all your options and alternatives beforehand. In some cases a credit card account can be a better fit.