Lessons in Finance – Home Equity

Home equity is the value of a house owner’s unencumbered interest in his property.  It is the difference between the fair market value of the home and the unpaid balance of the loan or mortgage and any other outstanding debt towards the home. There is rise in the equity when the mortgage is repaid or when the property appreciates.  Home equity is more frequently used as collateral to obtain loan such as home equity loan.  The rate of interest on such loan is partially tax-free.

Many house owners put this equity to work for them. They borrow against it utilizing the proceeds to improve their homes, pay for college tuition for their children or invest in businesses. This is done by obtaining a home equity loan. A home equity loan is a secured loan calculated on basis of the amount of equity available for your home.  It is possible for you to borrow nearly full amount of your equity with home as collateral.  This type of loans should be availed very carefully and the borrower should read the agreement and contract very carefully before obtaining this loan and paying fees.

A home equity loan is generally about 75% of the appraised value of the home after deducting balance which is due on the current mortgage and other liens. While choosing a lender, it is prudent to compare rates and fees of various lenders and financial institutions and then choose the right one suited for you.

Home equity loans are usually of two types:

1. A fixed rate mortgage

2. An adjustable rate mortgage

1. Fixed Rate Mortgage:  Fixed rate mortgage equity loans have fixed interest during the entire period of the mortgage or for the time fixed in the contract. Fixed rate mortgage offers more security for borrower especially for new house owners. It is more suited for house owners who wish to known the exact nature of the rate of interest they need to pay in order to document monthly budgets.  The only disadvantage of fixed rate mortgage is that it is less flexible and it has higher initial payments when compared with adjustable rate mortgage.

2. Adjustable Rate Mortgage: Adjustable rate mortgage have variable interest rates and not fixed rates of interest.  Various financial and marketing parameters and conditions determine the interest rates. If the interest rates go down then one has to pay a less amount as installment.  This home equity loan is highly fluctuating.  Moreover, it has greater flexibility as compared to the fixed rate mortgage.  One of the main advantages of this type of home equity loans is that the loan rate that is charged is generally tax-free.

While securing home equity loans, it is advisable to compare various fees charged to obtain loan as this has cascading effect on the amount of loan.  Various fees that are charged include title fees, appraisal fees, originator fees, arrangement fees, closing fee and early pay-off cost.