If you’re a homeowner, chances are that you’ve been seen many offers from finance companies to lend you money based on the equity you have invested in your home. A home equity loan is a loan extended to you that is secured by your home. The amount of the loan is based on how much ‘equity’ you have invested in your home. The basic explanation of ‘equity’ is ‘the difference between your home’s value and how much you still owe on the mortgage.
In other words, if you bought your home for $400,000 and put $80,000 down on it, financing $320,000, then your equity in your home on the day that you close the deal is $80,000. Now imagine several years pass. You’ve paid off $30,000 toward your mortgage – but at the same time, the value of your house has increased to $500,000. Your equity in your home is now $210,000: $500,000 (your home’s current value) – $290,000 (the amount you still owe on your home) = $210,000.
A home equity loan allows you to turn the equity you have in your home into cash by borrowing money and using your home as collateral to insure that you’ll repay it.
There are many reasons that people apply for home equity loans, though most fall into a few broad categories. The reason for taking out a home equity loan will often determine what kind of loan you apply for.
By far one of the biggest reasons that homeowners apply for a home equity loan is to consolidate their debts. If you have outstanding debt to several different creditors at several different interest rates, it’s often to your benefit to consolidate all those loans. To do that, you can take out a home equity loan for the amount that you owe on all your debts together – or more – then use that money to pay off all your outstanding debts in full. By doing that, you trade writing several checks each month for writing one check, which is often less than the amount that you’ve been paying on all of the debts combined. This is because you’re also trading in the higher interest rates on your credit cards and loans for a lower interest rate on one loan.
If you want to make improvements or repairs to your home, it only makes sense to get the money OUT of your home to do it. Home improvements are one of the top five reasons that homeowners give for taking out home equity loans. If the reason for making improvements is to increase the home’s value or prepare it for a sale, then you should definitely take a look at the home improvements that return the most on your investment. In many cases, when the reason for taking out a home equity loan is to pay for home improvements, the homeowner applies for a home equity line of credit rather than a regular mortgage loan.
Weddings, Vacations and College
Special events like weddings and vacations are the third most popular reason for taking out a home equity loan. For a wedding or other special event, where there will be multiple payments made to different merchants, a home equity line of credit is often a better choice than a lump sum home equity loan.
Regardless of your particular need, purpose or circumstance, borrowing against your equity is serious business. You must ensure to evaluate all your options and requirements. Once you have determined, you should then set up an action plan and look at before and after scenarios. When looking at after scenarios, the critical point is not only to look at how things will be on day of closing when you receive your “new money”, but to also forecast how things will look like in 1, 2, 3, 5 years. You don’t want to be taking a backward approach to increasing your net worth, improving cash flow, and saving on interest.
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