Tuesday, November 17, 2009

Things You Should Know Before Applying For A Home Equity Loan

For many Americans their most useful and valuable possession is the home. It is not only a safe place to live, but also a financial symbol that you are living the American dream. Embedded in the home is an added value called ‘equity’.
The equity is the amount you have already paid against the value of the home. To determine your home net equity, subtract the amount of the mortgage balance and any liens or second mortgage from the current fair market value of the home.
For example, if your home is appraised at $350,000 and you owe $200,000 on the mortgage, including liens or second mortgage, the net equity in your home is $150,000. This is like actual cash in the bank from which you can withdraw in two ways:
  • A Home Equity Line of Credit is a revolving fund secured by your home. It allows you direct access to about 75% of the appraised value of your home minus the balance due on the existing mortgage and any other liens. In determining how much cash you can withdraw, the lender will consider your ability to repay, by looking at your income, debts and other financial obligations and credit history.
  • Home equity line of credit typically involves variable rates of interest, based on a publicly available index, such as the prime rate published in major daily newspapers. As the rate will change with fluctuations in the value of the index, it is important to know which index is used, because most lenders base the interest rate you will pay on the value of the current index plus a ‘margin’, say 2 percentage point.
  • Typically, the best use of a home equity line of credit is when you need immediate cash to cover operating expenses in your business. The income generated by the business will enable you to repay the loan. Spending it on consumer items that will lose value with time is a misuse of a home equity line of credit, and probably will cost you your home.
  • The other way to withdraw cash from your home equity is by a Home Equity Loan. It allows you to get a loan from the bank by using the equity in your home as a collateral. But, unlike a home equity line of credit, a home equity loan is paid to you in a lump sum, and may involve a fixed rate of interest. The annual percentage rates (APR) for both ways of withdrawing cash from your home equity are calculated differently, and the methods of repayment may also differ.
  • Typically, a home equity loan is used for debt consolidation, home repairs and improvement, medical bills, or college tuition for family members. Resist the temptation to use the proceeds from a home equity loan for a vacation, a wedding or to buy a luxury car, because once the money is spent you will find there is not enough left to make the monthly payments.
  • You could use your home equity loan to start a new business, buy an existing business, or perhaps buy a second home. The bottom line is that the loan be used on something that will improve your financial position, as you will have to repay the loan with interest.
  • The interest charged on a home equity loan is usually tax-deductible, if the loan is used for its primary purpose. The interest rate is also low because as a secured loan it reduces the lender’s risk. Additionally, the borrower cannot hide the home or legally stop the lender from selling it in the event he defaults on the loan.
  • The costs of setting up a home equity loan, or a line of credit are similar to those paid when buying a home, such as property appraisal fee, application fee, up-front charges based on points, closing costs, including fees for attorneys, title search, mortgage preparation and filing, property and title insurance and taxes. Therefore, examine the terms and conditions of several plans before making your final decision.
  • In which way you decide to withdraw on your home equity, be fully informed that it is a loan secured by your home. There should be no question as to your ability to repay the loan. You may want to consider getting an insurance policy to cover the monthly payments if something happens, and you are not able to make the payments.
A home equity loan, or a line of credit will result in the loss of your home if you are unable to make your monthly payments; consequently, use it only to improve your financial position, or to raise funds in a true emergency situation. For additional information that could make the difference between losing your home and keeping it, go to the Federal Deposit Insurance Corporation website.

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