What Is An Equity Loan

The equity in your home is the difference between its market value and any outstanding debts or claims against it. There are people who believe that wealth is achieved by saving; they thus leave their home equity alone, letting the value of their property appreciate (or depreciate). But there are people who believe that there is nothing wrong with freeing up that equity and using the money in various ways, wise or otherwise.

An equity loan (also called home equity loan) is your way of accessing, or freeing up, the equity in your home. You could access the equity in another way, through a remortgage. However, your current mortgage lender may impose a redemption penalty if you do that. Thus, the other way, which also saves you from paying the penalty, is through an equity loan, which is an additional and different loan.

Equity loans are a form of secured loans, and the equity in your home is the collateral. You must be a home owner in order to qualify for the loan. Because they affect ownership of the home, they are very similar to a second mortgage; in fact, you will also draw up documents that impose a lien against your home.

You can get the money from an equity loan in one lump sum. You can also draw money as you need it, in which case your lender will establish a home equity line of credit in your favour. You may then write cheques against this line of credit every time you need to pay bills for the project you intended to finance with the equity loan. The interest is calculated only from the time you wrote the cheque for the bills.

Aside from saving you the costs of repayment penalty, a home equity loan can get you a tax deductible expense. Under certain circumstances, the interest paid on equity loans is classified tax deductible. Note that the interest you pay on credit cards and other unsecured debts are not covered by this benefit. If you suffer from bad credit and are not usually able to obtain unsecured loans, you may still get approval for an equity loan because your house will guarantee the repayment of your loan.

You must already have heard about your house being at risk if you default on your equity loan. That is something you will need to consider seriously if you obtain an equity loan. The other disadvantage to you is that your equity in the house is reduced or even eliminated (if you borrow the full value of the equity). Instead of saving your wealth, you have spent it. Even if you say you are going to pay it back, the truth is that you are simply starting all over again to save money.

Some lenders allow a loan amount greater than 100 percent of the equity value in your home. This will give you a lot of cash, but it also poses a risk to you. In a period of rising property values, you will have little to worry about, because the value of your home will still cover the amount of your equity loan. However, in bad times when property values may shrink (and those times have happened), you may find that the value of your property has become less than the loan amount. This is a state of negative equity, and it is something you should avoid.

So far the housing market in the UK, more particularly in London, has proven to be strong, buoyed up by rising demand and lack of housing supply. Property values have increased tremendously over the past years. Those who obtain home equity loans can only hope that valuations will continue to hold up.