Understanding the concept of a home equity loan
A
home equity loan is like a line of credit that allows you to borrow money, using your home's equity as collateral. The collateral is property that you pledge as a guarantee that you will repay a debt. If you don't repay the debt, the lender can take your collateral and sell it to get its money back. With a
home equity loan, you pledge the equity of your home as collateral. Equity implies the difference between the worth of your home and the debt you owe in mortgage (or mortgages in case there are many of them)
How low is low?
Are all those cheap
home equity loan ads that seem to stalk you for real? Those tempting ads that require you to "lock in rates while still at record lows" or ask you to "Compare up to 4 quotes fast and select one to be eligible for a 2% discount on interest rate" really cheap? This article will help you debunk some of the myths that surround
home equity loans.
Risk-Reward analysis underlying a home equity loan
At the outset, funding any business activity involves some degree of risk, regardless of the source of funding. Any activity that endangers your ownership of a home must be carefully considered. It is also extremely important to understand how business capital can be generated through the ownership of a house.
The following case scenarios outline when you should not consider taking a
home equity loan :
1. If your residence has around 20 percent equity and 80 percent loan outstanding on its value, then this strategy should not be considered under any circumstances.
2. First-time or new buyers who have just put a 10 to 20 percent down payment (their equity) on a home, and borrowed the balance, should not do any deal where a second lender comes in and writes a loan package to allow the owners to cash out that 10 to 20 percent equity in exchange for a 100 percent refinance.
The underlying rationale why you should not consider adopting the strategy outlined above is simple. Your contribution to the ownership of the house comprises your equity, and if a second lender writes a
loan package to allow owners to cash out the equity for a 100% refinance, in case of an economic downturn, you might be walking on thin ice. Your lender could very easily foreclose, and your equity and home are gone forever.
However, in some case scenarios, taking a
home equity loan may be prudent, and has been outlined below:
If you have been a longer term home owner with more than 50 percent of your home's value as equity (the outstanding
loan is less than half the market value of the house), then borrowing from your home can work to provide capital for your business, provided you approach it prudently. Use the checklist below to ensure you are a good candidate for a
home equity loan :
1. Get a fair market appraisal on your house
2. Know the exact outstanding balance on all your mortgages (first, second, home equity line, other liens must all be combined here).
3. Subtract the total debt from the appraised valuation; the difference is your equity
4. Divide the equity figure by the appraised valuation; this is your equity percentage. If this percentage is over 50 percent, then this could work for you.
5. A lender will quote you a rate and monthly principal and interest to borrow out equity. Some may want interest-only payments, so the loan balance outstanding does not get paid down over time.
Thus as seem above, a cheap home equity loan may not always be cheap. It depends
upon the equity contribution of your current home, and the terms
of the home equity loan.
