What Type of Account Is a Home Equity Loan?

A home equity loan uses your house as collateral, and it is considered a secured loan, one that presents a low risk to the lender. If you default, the financial institution can sell your house to recover the cash you borrowed. Meet with several lenders before you sign a home equity loan contract. Compare the annual percentage rate, fees and additional terms each offers to select the best fit for your financial situation.

Home Equity

An appraisal fee is one of the costs you might incur during the process of getting a home equity loan. That’s because the amount the bank lends you is based on the difference between your home’s current value and the amount you owe on it. This difference is known as home equity, and the borrower often pays for the appraisal that helps determine it.

General Features

A home equity loan is a one-time sum the bank transfers to you. Also known as a second mortgage, this type of loan usually requires that you pay closing costs and agree to a fixed annual interest rate for the term of the debt. Although you will not benefit from a fall in the annual percentage rate (APR), you will also avoid potential hardship if the rates suddenly go up. Besides, as a general rule, the U.S. tax code allows you to claim the interest you pay on the loan as an itemized deduction.

Borrowing and Repaying

The Federal Trade Commission says banks normally lend 85 percent of a home’s equity as a second mortgage. Take that into consideration when planning your budget, as the equity loan might not cover the entire expense you need paid. If that’s the case, figure out your other options for paying the remaining balance before you incur a major, but insufficient, debt. Because the APR is fixed, expect to pay equal installments to the bank every month. While first mortgages are usually 15- or 30-year loans, equity loans can come with much shorter payment periods. Verify with the lender how long you have to repay your debt. Some second-mortgage agreements demand repayment within 12 months.

Caution

Losing your house is the greatest -- and a very real -- risk of taking out a home equity loan. Although you cannot control unexpected events that might keep you from making your loan payments, you can take precautions to fend off unscrupulous lenders. Refrain from continuous offers to refinance for a better APR or to increase your loan. Even though your interest rate might go down, you will incur more fees that only benefit the financial institution. Besides, acquiring a larger loan means increasing your debt. Even if your APR is now lower, you’ll end up paying more interest because it is computed on a higher principal. Find out whether any extras you are offered, such as insurance, are mandatory. If they are not, be suspicious of the offer -- the lender is possibly trying to get unnecessary money out of you. Verify at closing that the terms of the contract you are about to sign mirror what you informally agreed to with the lender. Walk away if they are not. A reputable lender wouldn’t present you with a different package at the last minute. Also, do not accept a second mortgage if you know you cannot make the payments, even if the bank is willing to let you borrow the money. Remember that the home equity loan is secured because you basically pawn your house to get it. Unscrupulous lenders might not care whether you can pay them back because they can always foreclose on your property.

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