Home equity loans or second mortgages can help borrowers in various ways. It can pay for home improvements, boost emergency funds, or repay student loans. However, as with other loans, this type has some downsides. For this reason, a borrower needs to research everything they can about home equity loans.
This article looks at a home equity loan and how it can be used.
What Is a Home Equity Loan?
A home equity loan has several other names, such as equity loan, second mortgage, or home equity installment loan. It is a consumer debt allowing borrowers to get loans against their home’s equity. The basis of this amount is the difference between the homeowners’ mortgage due balance and the home’s current market value.
The basic formula used by lenders such as Vamo to determine the amount is:
Home Value – loan balance = the home equity
Borrowers can get this loan for various reasons, such as debt consolidation or to achieve other financial goals. Loan companies offer equity loans to residential and non-residential properties.
How Do Equity Loans Work?
Notably, there are two types of equity loans. These are home equity loans and home equity lines of credit (HELOCs). These differ in how a borrower receives money and repays it.
Home Equity Loans
These are second mortgages to a property, meaning the debt is secured by the home. When approved, a borrower receives this amount as a large sum and starts making payments immediately. It also has a fixed interest rate where one repays the arranged installment monthly for the duration of the loan. It is ideal for when one has an urgent matter to handle.
Home Equity Lines of Credit (HELOCs)
This type of home equity loan works like a credit card. It allows the borrower to withdraw as much money as they need up to the credit limit within the draw period. This period can last up to 10 years.
This credit allows borrowers to reuse it as they pay the HELOC principal. It also gives them the flexibility of getting the funds when required. Additionally, users can select to repay a combination of interest and the principal amount or just the principal.
These loans have varying rates which could sometimes mean having lower monthly payments. Once the draw period ends, a borrower must pay the principal balance and interest.
Pros and Cons of Home Equity Loans
There are advantages and disadvantages to getting a home equity loan. First, these loans provide borrowers with an easy cash source. Borrowers with steady incomes can access low-interest-rate loans. It is also secured debt that consumers can access after lenders run the appraisal of the home.
Home equity loans also have low-interest rates than others. Finally, loans in the Philippines provide reliable loans for borrowers who need to fund expensive goals.
Apart from being beneficial to borrowers, home equity loans have several disadvantages. First, since they are an easy solution, a borrower can fall into a cycle of spending and borrowing, leading to more debt. It is a common problem observed by loan companies, and they coined a term for it: reloading. It is the habit of getting a loan to pay off an existing loan to get more credit to buy more things.
This behavior leads to a debt cycle, and it attracts high fees leading to more trouble. It can eventually lead to bankruptcy and foreclosure.
Additionally, when borrowing for home improvements, a borrower should ensure the amount goes to things that add value. Some improvements may only be valuable in the eyes of the borrower and not the loan companies.
Choosing the Best Home Equity Loan
Apart from looking at the pros and cons of these loans, borrowers should do more research on this. Doing this allows them to get the best market terms and interest rates. For this reason, they should compare the different lender’s loans and fee structures.
Notably, different loan companies in the Philippines have various qualification requirements. These rates can be determined based on the home value and a borrower’s creditworthiness. One can negotiate with a lender for better rates if one has a good score and credit history.
Conclusion
Properties can be leveraged for money if a borrower needs more financial assistance. Home equity loans are easy to access and offer borrowers quick access to money. However, a borrower can fall into a pitfall such as reloading if not careful. For this reason, one should evaluate all the drawbacks before applying for a loan.
Moreover, borrowers can assess and review their financial situation before borrowing against a home or property. They also should go through the bank’s terms and conditions to ensure they can meet the payments as needed without compromising payments for other needs.
