Finding the best option to access you home¡¯s equity can be a challenge, demanding more time and expertise than most people can spare. Whether your credit is stellar or less than perfect, we'll find the best home equity loan option for you!

What is a home equity loan?

A home equity loan is a loan that uses your home as collateral. Your home equity is the part of your home that you actually own and this is the guarantee for your loan.

Your home equity is calculated by taking the current value of your home and subtracting your mortgage. For example, if your home is worth $150, 000 and you have a $100,000 mortgage, you have $50,000 of equity in your home. A home equity loan allows you to borrow money using your equity of $50,000 as security for the loan.

A home equity loan, often called a second mortgage, reduces your equity or ownership in your home. Since your home guarantees your loan, if you default on the payments, you can lose your home.

Advantages and disadvantages of a home equity loan.
A lower interest rate and tax deductions are the two major advantages home equity loans have over other types of debt.

Since a home equity loan is secured by your home, it poses less risk to a lender than does a non-secured personal loan or credit cards - this lower risk is passed on to you in the form of a lower interest rate.

The second major advantage is that regardless of the way a home equity loan is used, the interest you pay on the first $100,000 you borrow is tax deductible. Credit cards and other types of non-secured loans do not have this tax benefit. This means that if you pay $3,000 in interest on your home equity loan, you will reduce your taxable income by $3,000 at the end of the year. If you use a home equity loan for home improvements or to buy another home, you can deduct the interest paid on the first $1 million that you borrow. The reason for this is that home improvement loans are similar to first mortgages for tax purposes. You should consult a tax advisor about the specific tax benefits available to you.

The biggest drawback of a home equity loan is the fact that your home is on the line and you could lose your home if you default on your payments. When you borrow from your home's equity you also reduce the equity or ownership you have in your home. This means that you trade ownership or equity in your home for cash that you will use for some some other purpose. In addition to interest you will pay on the loan, there are also costs associated with taking out a home equity loan - these costs are similar to the costs you paid when you bought your home.

There are two basic types of home equity loans: the standard home equity loan and a home equity line of credit. Another way of borrowing against home equity is cash-out refinancing.

The Standard Home Equity Loan
A standard home equity loan, (also called a term loan, a closed-end loan or a second mortgage installment loan), works like a traditional loan. You receive a lump sum payment at a fixed interest rate and you pay the money back in monthly payments over the life of the loan. Since the interest rate on the loan is fixed, your monthly payments will also be fixed.

An example of this is a home equity loan for $30,000 with an interest rate of 7.5% where you pay the money back in monthly payments of $356.11 over the 10 year life of the loan.

Home Equity Line of Credit
A home equity line of credit works like any other line of credit. You are granted an amount you can borrow and you draw money from the account as you need it. You pay interest on only the amount actually borrowed and the interest rate is variable over the life of the loan. While most home equity lines of credit have a variable interest rate, a fixed interest rate can sometimes be negotiated. A home equity line of credit is 'revolving' meaning that you can borrow money, pay off the borrowed money and then re-borrow that money. The money in a home equity line of credit is accessed using specially issued checks or credit cards

Here is an example of a home equity line of credit: You are given a $20,000 home equity line of credit. You borrow $10,000 dollars and are charged a 5% interest rate. The interest rate for the home equity line of credit is not fixed but varies with changes in interest rates. If you pay back $5,000 towards the principal, you still have $15,000 in your line of credit that you can borrow against as needed.

Cash-out Refinancing
While cash out refinancing is not a type of home equity loan, it does allow you to borrow against the equity in your home. In cash out refinancing you take out a new mortgage that is greater than what you owe on your current mortgage - you pay off your current mortgage and use the difference as a home equity loan.

Here is an example of cash out refinancing. Your home is valued at $150,000. Your mortgage is $100,000 and you have $50,000 worth of equity in your home. When you bought your home, you got the going mortgage rate which was 9%. Interest rates have since come down and you decide to take advantage of the lower rates and also borrow $20,000 from your equity for a home improvement project. You take out a new loan for the $120,000 at 6% - you use $100, 000 of that to pay your old mortgage and $20,000 for your home improvement project. You now have a $120,000 mortgage at 6% where as you previously had a $100,000 mortgage at 9%. The difference of $20,000 is the way in which cash out refinancing replaces a home equity loan.

Cash out refinancing typically has a lower interest rate than a home equity loan but closing costs associated with cash out refinancing are higher than closing costs associated with a home equity loan.

Top 5 Mistakes People Make When Taking Out a Home Equity Loan

1. Choosing a home equity lender for the wrong reason (i.e., the lowest rate, your existing lender.)

People choose home equity lenders for all the wrong reasons. Getting a low rate is important, but it's not the only consideration when you want to take out a home equity loan. Lenders may offer the lowest rate but charge extra fees (loan fees, origination fees, copy fees) so that in the end you'll pay more for the home equity loan even though your rate may be lower. The only way to protect yourself is to wait for the Good-Faith Estimate (GFE) which should list all the closing costs. Compare the GFEs from a number of home equity lenders.

But comparing GFEs is not the only story when you want to take out a home equity loan. If time is important, you want to choose a mortgage company that is capable of acting quickly. Ask each company to give you their average closing time for loans similar to yours.

Ask around among your trusted friends. Find out who took out a home equity loan lately and ask them what they thought of the company. Don't assume that your existing lender is any better than a new lender. Since most loans are sold in the secondary market, everyone has to meet certain criteria, and your existing lender will probably require the same documentation as a new lender. However, once you have a commitment from a new lender, it doesn't hurt to ask your existing lender to beat it. Often times they will. We will get you the best rate available.

2. Not getting everything in writing when seeking a home equity loan.

Get everything in writing. No matter what the Loan Officer tells you about your home equity loan, ask him/her to confirm it in writing. Don't believe someone when they tell you that your home equity rate is guaranteed. Get it in writing.

3. Not knowing the difference between a home equity loan and a home equity line of credit.

A home equity loan is a loan, like a 2nd mortgage. A home equity line of credit is a credit line - money that is made available to you to use when you need it. There's a big difference. Some credit lines have interest rates which are adjustable and which can go as high as 15% or more.

4. Not knowing the appraised value of your home.

Home equity loans and home equity lines of credit are based on the difference between what you owe on your house and what your house is worth. Many people go ahead and try to get a home equity loan on their home without knowing the true value. There are many places you can get an estimate of the true value of your home. Many realtor sites have home value estimators on their site. For the price of listening to a mortgage company try to sell you a mortgage, you can get an approximate value for your home.

Check the recent sales in your neighborhood and try to find a comparable house in a comparable location. Or you can ask the appraiser to do a drive by and give you a verbal estimate of the value of your home. If it's in the right ballpark, you can order a thorough appraisal.

5. Not doing the math on a home equity loan.

Having a home equity loan can be better than taking out a 2nd mortgage because the origination costs are less. However, the monthly interest rate may be more with a home equity loan than with a 2nd mortgage. So, depending on how much you are going to need and how soon you are going to need it, you may find that a 2nd mortgage is a better way to go.

One of the biggest mistakes people make with home equity loans is to take out a large amount of money and put it into their checking account. You may pay as much as 8% for the home equity loan while the money you took out is only earning 2% in your bank account. Recommendation - only take out as much as you are planning to use.

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