How Do Home Equity Loans Work and When Should You Get One?

Buying a home in our current economy is usually impossible without taking out a mortgage. Although this type of loan is extremely useful when you plat to buy your first home, its cost and term can be extremely limiting. This is mainly due to the fact that mortgages can take up to 30 years to repay and the monthly instalments have to be paid regardless of whether or not your income changes.

For all intents and purposes, having to pay a mortgage usually means that you may be unable to handle other types of debt, at least during the first few years of the loan. Once your monthly income increases, you may be able to take out another loan, but this may still stretch your finances.

This often leads to a situation where homeowners need to renovate their house but cannot take out a secured personal loan in order to cover the costs of the project. However, there is an easy way to borrow the money that you need, provided that you’ve made enough payments on your home.

What Are Home Equity Loans?

Home equity loans are secured loans that are guaranteed using your home as collateral. In most cases, you will have to repay the loan through equal monthly payments, the same way you pay your mortgage, however, this depends on whether the lender offers a fixed rate or a variable one.

The term of the loans depends solely on the lender, however, the amount of money that you can borrow is calculated by looking at how much equity you have in your home. For example, if you have purchased a £400,000 home and your mortgage is £250,000, you will have to calculate 80% of the value of your home and then deduct the mortgage from the result. In other words, 80% of £400,000 is £320,000, from which you have to subtract £250,000. This leaves you with £70,000 as the amount of home equity that you will be able to tap into as collateral.

One of the most important things that you will have to keep in mind when it comes to home equity loans is the fact that if you cannot repay the money, along with the interest, the lender will be able to take possession of your home.

When Is Getting a Home Equity Loan a Good Idea?

Generally speaking, home equity loans are relatively safe, provided that you pay attention to the terms and conditions that you are agreeing to. Ideally, you should aim to find a lender that offers a relatively small, fixed rate that will allow you to make the monthly payments without putting too much strain on your finances.

Furthermore, only take out a home equity loan if you do not have any outstanding debt other than your mortgage. This will minimize the risk of losing possession of your home in favour of the lender. You should also only apply for one of these loans once you are absolutely certain that an unsecured personal loan would not be enough to cover the costs of your project.

Be Smart about How You Borrow Money

Try to always be smart about how you borrow money, especially when to loans that are secured against your home. When it comes to home equity debt, you have two options. You can take out a loan, which will be given to you in full at the beginning of the term. However, if you do not need a large amount of money at once, there is also the possibility of taking out a home equity line of credit which will work similarly to a credit card.

Look at what types of home equity loans or lines of credit the lenders are offering and choose the right one for you. In the long run, it will make a world of difference.