How home equity loans work + How they compare to other loans
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Home equity loans explained

Take advantage of the equity you’ve built up in your home by using it to finance your next big purchase.

Home equity loans can be a great way to help you take your next step, whether it be to a new car, to home renovations or to any other large purchase.

While car loans are the most common type of secured personal loans, a vehicle isn’t the only way to guarantee a loan. If you own your own home and have built up some equity in it, you can use that equity as a guarantee on your next loan. Find out how it works in this guide.

How does a home equity loan work?

A home equity loan works the same way as other secured personal loans. When you apply you will need to provide details of your mortgage, your personal financial position and the reason you’re taking out the loan. Your application will be assessed and if approved, you will be given a loan based on how much equity you hold and how much the lender thinks you can afford to repay.

How much you own in your home will be used as collateral for the loan. If you were to default on the loan, the lender could recoup its losses by taking ownership of that equity.

Compare home equity loans vs. personal loans

Calculating how much equity you have

Home equity is essentially the difference between your property’s value and any debt you hold against it. Typically, you’ll be able to borrow up to 80% to 90% of your home’s value minus the debt you hold against it. For example, if your home is worth $500,000 and you’ve paid off $300,000, you’ll have $200,000 left on your mortgage. Here’s how much you’ll be able to borrow with a home equity loan in that scenario:

  • 80% of a $500,000 home = $400,000
  • The amount of debt on the property = $200,000
  • Value minus debt = $200,000

Types of financing you can secure with your home equity

The types of loans available when using your equity give you real flexibility:

  • Fixed-term secured loan. A secured loan is guaranteed by collateral you put up and can be used for any purpose. It is given to you in a lump sum and you pay it back in installments, usually over a period of one to seven years. As the loan is secured you can enjoy a more competitive rate.
  • Line of credit. As a continuous source of credit, you can draw on this loan as and when you need to. You’ll have access to the amount of credit that you’re secured for and be required to make regular repayments and as you repay the credit it will become available again. You may see this product marketed as a HELOC, or Home Equity Line of Credit.

Is a home equity loan the same as a home equity line of credit (HELOC)?

Not quite. While both types of financing draw from your equity as a source of collateral, a home equity line of credit (HELOC) functions more like a credit card. You have a large amount of money you can draw from at any time for the loan period, usually 5 to 15 years.

A home equity loan usually has the same repayment period, but you’re advanced the lump sum immediately. Because of this, you must pay interest on the entire amount (like a regular mortgage). On the other hand, if you take out a HELOC, you only have to pay interest on the amount you borrow from the possible pool of funds — say $50,000 of the total $100,000.

What kind of purchases and investments can you make with a home equity loan?

While the loans themselves are secured, there aren’t many restrictions on how you use your loan. You can use the money for:

What are the benefits of home equity loans?

  • Competitive interest. Your loan is secured by a valuable and appreciating asset, your property, so you will usually get a competitive interest rate.
  • Flexible loan purpose. You can usually use the loan amount for whatever purpose you need.

Do you need to apply with the same lender you have for my mortgage?

No, you don’t. If you decide to apply with a different lender you will need to provide details of your mortgage, including your total loan and how much equity you hold.

Is there anything else to consider before applying?

This is a risky type of loan should you default. Failing to repay the loan could result in the lender taking the equity you have in the property to pay the loan. Before you apply, consider how financially stable you are and if this is the right type of loan for you to take out.

A home equity loan can offer you a low interest rate as well as a flexible way to finance a personal purchase. However, as there are risks involved, remember to consider your loan options before you apply.

Want to apply for an unsecured loan? Consider these online lenders

Rates last updated February 26th, 2018

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