If you have spent anytime filling out paperwork to buy a new Fort Collins CO home, you have no doubt heard the term “home equity.” But what exactly is it? The equity in your home is the current appraised value minus the amount you owe on the home. As you pay off more debt owed on your home, the equity increases.
Two types of home equity debt exist: a home equity loan and a home equity line of credit, both of which are sometimes referred to as a second mortgage. Your initial mortgage goes toward the purchase of your home, and any future home equity loan is given to you by the bank for various reasons.
Home Equity Loan
When you secure a home equity loan, you are borrowing a lump sum of money using your home’s equity as collateral, or property used as a promise to repay a debt. If the debt is not paid back, a lender can take possession of the collateral and sell it in order to make repayment. Home equity loans have a fixed interest rate, fixed term limits, and regular payments until the loan is paid off.
Home Equity Line of Credit
When you are approved for a Home Equity Line of Credit (HELOC), it is a bit like having a credit card. The bank approves you for a loan amount and you withdraw the funds as you need them. A HELOC has a revolving balance and allows you to borrow a certain amount for the entire life of the loan. A HELOC has a fluctuating interest rate, and payments will vary based on how much you owe and the terms agreed upon.
When You Would Use a Home Equity Loan or Home Equity Line of Credit
All homeowners come to a point where they have to make repairs or perform maintenance on their home, and sometimes these situations are unexpected. If you have not planned for these times, or the expenses are out of your budget, you have the option of getting a loan or line of credit.
Should You Use Home Equity?
When the need arises for extra cash, you have the option between a home equity loan (which will pay you immediately) and a home equity line of credit (disbursed over time). Which of these loans is right for you depends on a few factors.
The Wall Street Journal gives homeowners a few tips on securing home equity funds.
A regular home equity loan is a good idea for things like:
- Kitchen remodel
- Deck upgrade
- Bathroom renovations
- Room additions
A HELOC would be a better option if you are looking for:
- Payments over time
- A safety net for emergencies
- Paying for college
- Remodeling projects that are spaced out over several years
The WSJ also notes that when you receive home equity as a source of income, the approval process is not quite as detailed as the mortgage approval process. Also, your credit score and credit history have little impact on loan approval or the raters you will pay, due to the fact that your home is the collateral. However, not staying current on payments can mean your home is repossessed. There are fees and interest rates included in the process, but homeowners can shop around for the best deal.
As with any financial decision, read the fine print and terms connected to your transaction; do your research and stay aware of any conditions included in your loan.