What is an Equity Loan?

Buying a home is a major milestone in anyone’s life. You’ve worked hard to maintain your home through the years. Perhaps you’ve upgraded your kitchen, installed new floors, painted a new exterior color, or remodeled the bathroom. Not only do these enhancements bring personal satisfaction, but they may also increase an important aspect of your home: its equity.

In its simplest terms, home equity is defined as your home’s current market value minus what you owe on it. Equity is your asset, part of your net worth, and it rises with every mortgage payment and every time your home’s worth increases in market value. It is the real monetary amount of how much of your home you really own. It is important to know about equity because any equity you have can potentially be accessed in cash by getting a home equity loan. It is easy to see why so many other homeowners express such interest in and have questions about home equity loans.

What are Home Equity Loans?

The first question homeowners may ask is, “What is a home equity loan?” It is a type of loan that enables you to access the equity you have in your home and convert it into money that you can use. These loans are secured by the property, and the home is used as collateral. Loan proceeds may be used for almost anything – for home improvements, to pay bills, or cover expenses you otherwise may not have been able to.

Types of Loans on Home Equity

When considering accessing equity through a home loan, you usually have three main options from which you can choose.

Standard Home-Equity Loan

In general, a standard home equity loan is disbursed as a single lump sum with a fixed interest rate. Also commonly known as a second mortgage, standard home equity loans essentially allow you to access your available equity while you continue to pay a monthly mortgage payment over a predetermined length of time. Many homeowners like having a fixed interest rate for a fixed number of years, so they know exactly how much they owe and when it is due. This is beneficial for budgeting purposes and for the security of knowing you will pay an amount of interest you are comfortable with. One risk to a fixed interest rate is that if market rates decline, then you still must pay the higher rate. If you want to use the money for one single big expense, the standard home-equity loan is a typical choice.

Home Equity Line of Credit

A Home Equity Line of Credit, also known as a HELOC, is a line of revolving credit with a variable interest rate. The line of credit has an initial limit set, and you can borrow up to that amount. The convenience of accessing cash when desired, while only getting charged interest on the portion used is very attractive to some homeowners. However, disadvantages of a HELOC include the fact that you must continue to pay a monthly mortgage payment on the amount borrowed, and that the line of credit can be decreased or closed by the lender without warning. If you want to use the money for various reasons over time, the home equity line of credit loan is a common choice.

Reverse Mortgage Loan

If you are age 62 or older, you may be eligible for a third option called a reverse mortgage. With this kind of home equity loan, you may access a portion of your equity, and also enjoy one benefit that the other two options cannot offer: no monthly mortgage payments. Borrowers are responsible for paying property taxes, homeowner’s insurance, and for home maintenance. If you are interested in keeping your monthly expenses low or have a fixed income, this kind of advantage in a loan may provide just what you need to build up your retirement finances. Also, these funds can be disbursed in a lump sum, monthly installments, a line of credit, or a combination of the three, making reverse mortgages not only comparable to other home equity options, but more flexible as well.

Instead of repaying the balance and interest as a monthly expense, repayment of a reverse mortgage is deferred to when the last borrower permanently leaves the home, or does not comply with the loan terms. This means that as long as you continue to pay property taxes and insurance and meet all the loan terms, then you may continue to live in your home without a mortgage payment.

What are Home Equity Loans Used For?

Home equity loans offer flexibility in how proceeds are used. The following provides a few examples of how homeowners have utilized their funds:

Home Improvement and Repairs

Home improvement and repairs are one of the most popular uses for home equity loans because many homeowners view it as pulling money from your equity and re-investing it back into the property. Home improvements can make your home more comfortable for you and perhaps, depending on the kind of updates, may even add to your home’s value. Also, if there is any damage to the property, then it is a good idea to repair it so you can preserve your home’s value, and thus your equity.

Medical Bills

If there is one expense you should not compromise on, it is your health. Medical procedures may put quite a bit of financial stress on families, but home equity loans may help you afford to pay for medical expenses and bills necessary for your well-being. With funds from equity, you can feel confident that you do not have to sacrifice good health for financial reasons.

Consolidating Bills

Bills incurred from credit cards, student loans, or other personal loans, may become overwhelming, so some homeowners may find it easier to pay off outside bills with a home equity loan. In some cases, it may even be more affordable since interest rates for home equity loans can sometimes be lower than credit card interest rates. This use is most common with reverse mortgages, since borrowers must pay off their existing lien, and without a monthly mortgage payment, “borrowers are responsible for paying property taxes, homeowner’s insurance, and for home maintenance”, it makes it easier to use the extra cash flow to pay down bills.

Balancing Your Retirement Portfolio

Equity loans are especially useful when you want to balance your retirement portfolio. During your retirement years, your investment portfolio may experience some volatility. Fortunately, an equity loan such as a reverse mortgage can be established at the outset of retirement and drawn upon to provide income. This allows the retiree’s portfolio, like a 401(k) plan, more time to grow. If the portfolio is down, the ability to avoid drawing from it allows more time for it to recover, and reduces the risk of exhausting it during retirement.

In addition, a reverse mortgage can be used to draw upon instead of accessing Social Security benefits right at retirement age. Deferring Social Security payments at the onset of retirement allows you to collect greater monthly payments later in life.

Equity loans are meant to help you access the money in your home – an often unthought-of and untapped asset that can help you live more comfortably. If you are interested in exploring how to access your equity, it is important that you first assess what your needs are so you can choose the loan type that would be best for you. To learn more about how home equity loans work you may want to speak with your financial advisor, and, to find out more reverse mortgage information, contact an American Advisors Group loan professional at 1-888-998-3147.

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