How do home equity loans work?


Borrowers may be confused when it comes to how home equity loans work.

What is a home equity loan?

Home equity loans are any loans using your house as collateral. For example, your first mortgage is also a home equity loan. However, home equity loans and lines of credit as such are most commonly used in a second lien position. This doesn't mean that you cannot use a home equity loan to purchase property and use it as a first mortgage. However, interest rates on HELs and HELOCs are comparative to second mortgage loan rates, and as such they are higher than a first lien loan rates.

How do home equity loans work best?

  • HELs and HELOCs will have lower rate than a second mortgage loan. If you have less than perfect credit, with a home equity loan you will qualify for a larger amount.
  • Home equity loans have deductible interest. Under certain circumstances, tax deduction benefits are as big as first mortgage interest tax deduction.
  • Home equity loans are convenient to use for funding college education, house renovation, consolidate debt, pay for vacation, or buy rental property.
  • To make best use of HELs and HELOCs, avoid being scammed by con artists and always make sure you can afford the payments.
  • When deciding whether to use a home equity loan, make sure you educate yourself about their pros and cons. If after doing a research you are still unclear about what home equity loans are and how they work, attend credit counseling and figure this out.
  • Do reasonable loan comparison shopping before accepting an offer.
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