A home equity loan is one you borrow against your own equity, also known as a second mortgage. The homeowner takes a second home loan while in debt for the first mortgage. In this article, we’ll learn about the profit and loss of home equity loan.
In a home equity loan, the loan amount is based on the difference between the current market value of the home and the homeowner’s mortgage balance due. Home equity loans have fixed interest rates. While the alternative is home equity line of credit (HELOC) loans, they are flexible as they have variable rates.
The home works as collateral for the lender and also guarantees the lender against any defaults. If the homeowner defaults on the home equity loan repayment, the lender can foreclose on the house.
How Does A Home Equity Loan Work?
Home equity loans are fixed-rate loans. The borrowers ask for a loan tenure of 5–15 years. However, in some cases, it may go up to 20 years. The interest rate remains the same for the loan term period.
The lender provides the amount based on the difference between your house’s market value and the homeowner’s due balance. It also depends upon the loan-to-value ratio.
Profit And Loss Of Home Equity Loan
Following are the various profits you can gain from home equity loans:
Easy To Obtain
Home equity loans provide easy cash to the borrower against their home equity. Borrowers can ask for a lump sum amount and can lock in the interest rate for the loan life period.
Lower Interest Rates
Home equity loans have lower interest rates than other loan types. You pay the same interest rate for the entire loan period.
Possible Tax Deductions On Interest Paid
Borrowers can get a tax break on the interest they pay on home equity loans. This is possible only when they utilize the loan amount for home improvements, maintenance, or any home-related expenses.
No Restriction On Loan Amount Expenses
Borrowers can utilise the loan amount for anything. They can pay the bills, fund a child’s education, wedding, vacation, or repay debt.
On the contrary, following are the losses you might have to bear with home equity loan:
The Borrower Gets Into The Debt Trap
The borrower gets into the debt trap due to easy loan solutions. Home equity loans can lead to selling off the house or property to repay the debt. Since the house works as collateral, the lenders can use it any time to get the remaining amount.
You Are At A High Risk Of Losing Your Assets
The home works as a guarantee for the lenders. If the borrower cannot pay, the lender can get back his money by selling off the house. In worst-case scenarios, lenders sell the home to return the remaining amount.
Closing Costs And Fees
The closing costs of home equity loans generally fall between 2% and 5% of the loan amount. This can be expensive when the loan amount is significant. You may get an early termination fee if you pay the amount ahead of schedule.
Who Is Qualified To Obtain Home Equity Loans?
Generally, everyone can apply for home equity loans. However, lenders look for borrowers who can repay the loan. So, you need to provide documents to get home equity loan approval.
The lenders will look at your credit score and other financial documents, such as your previous month’s pay stubs, tax returns, investments, and bills. An appraisal is required before the loan amount is released.
This whole process may take weeks. Lenders don’t take risks, so they do all the verification and ask for collateral, which is the borrower’s house.
Home equity loans are beneficial as they provide a lump sum against your house’s equity. However, you need to consider the profit and loss of home equity loan and get the best deal for yourself.