Simply put, home equity amounts to the interest a home that actually belongs to the homeowner, as opposed that which is held by the bank. It is a combination of the down payment made on the original purchase price of the home, the amount of the mortgage that has already been paid and the increase in the home’s value.
While home equity represents an investment, which over time can be safer and more profitable than other types of investments, there is not much that can be done with it until it is converted to cash. For a homeowner to be benefit from their equity, they will need to be able to extract it. That is where home equity loans and lines of credit come in.
Benefits of the Home Equity Loan
One of the major benefits of equity release in a home comes from the possibility that the value of the home may increase over time. The housing market is relatively stable when compared to, say, the stock market, meaning that in most cases, the person who invests in a home has a reasonable chance of making a profit. In order to be able to make their equity in a home liquid, the homeowner will have to use it as collateral for either a home equity loan or line of credit. This means that equity in a home can amount to a sizable sum of cash, especially if the value of the house has substantially increased since the original home loan. Depending on the amount of the increase in value, the homeowner may be able to borrow substantially more than they have put into the home. This type of loan can be useful to pay for education or to start a business or even for the purpose of buying a second home. Home equity loans are also a good way to consolidate debt. Someone who wants to do this would borrow the money, repay all their debtors, at which point they would only owe one debt.
Benefits of the Home Equity Line of Credit (HELOC)
Home equity lines of credit are another way of making equity liquid, and while it can have some of the same benefits it operates on a slightly different principle. Both of these result in result in home equity debt. The line of credit is typically used for long terms needs, where money will be needed in smaller sums over a period of time, rather than all at once. With a HELOC, the homeowner will borrow the money in instalments. This means that while they will be approved to borrow a certain amount of money, they will not actually be required to pay interest on the entire sum. Instead, they will pay interest only on the amount of money that they actually use. While the rate of interest on HELOCs are typically not fixed, meaning, it will fluctuate according the rates set by the Federal Reserve, they do offer flexibility to the borrower as far as how much money they borrow.
Refinancing a Mortgage
Home equity loans can be used to secure another loan with a lower rate of interest. In other words, the homeowner will borrow a second loan in order to repay the first. For this to be a good idea, the second loan will have to be repaid with a lower interest rate than the first. This is only really effective if the interest rate on the second loan is significantly lower than the first. This is a good way to lower monthly payments or to pay down the principal on a home loan more quickly, as opposed to just paying on the interest.
This article was completed by freelance writer Jem. He specialises in equity release and advising people on such matters, he does believe however that anyone considering such action should referee to their own personal equity release guide or specialist. Follow Jem at @writerjem on Twitter.