How Exactly Does a Home Equity Loan Work?


Quick Answer

A home equity loan allows a homeowner to receive a cash payment in return for a stake in the value of a specific property. This value is equal to the difference between a property's market value and the remaining mortgage balance.

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Full Answer

A home equity loan is more commonly referred to as a second mortgage. In return for a cash payment from a financial institution, a home owner establishes his property as collateral. This collateral serves as security in case the home owner defaults on the loan. These loans are suited for a person who requires significant up-front capital for a specific purpose, such as starting a business or paying tuition.

Most home equity loans carry a fixed interest rate that is agreed upon by both parties. This interest is paid monthly. However, a person should conduct a cost-benefit analysis and consider property valuations when taking on the obligation. If property values increase, the value of the home equity loan decreases since the loan amount was agreed upon prior to the increase in property value. Banks, savings and loans, and mortgage companies offer home equity loans. These organizations also offer home equity lines of credit for those looking to draw capital as necessary instead of receiving the total loan value up front.

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