What Equity Is and How to Use It
With the current popularity of loans based upon home equity, a
lot of people find themselves wondering exactly what equity is
and how it's used.
If you're one of these people, take heart... by the end of this
article you'll have a much better understanding of home equity
and exactly what happens when you take out a home equity loan or
a home equity line of credit.
First of all, though, you need to learn what home equity is and
how it is created.
Defining home equity
Home equity is an often-used term in the advertising of
financial services these days, but most of the ads that use it
don't bother explain what home equity is.
At its most simple, home equity is the amount of the house or
other real estate that you actually "own"... it's the portion of
the mortgage on the property that you've actually paid off.
A house that was purchased a few months ago will have little to
no equity, since at best only a few payments have been made
toward the mortgage amount; a house that was purchased 15 years
ago, though, will have a good portion of the mortgage paid off
and will therefore have quite a bit of equity built up.
The more equity there is in a piece of real estate, the more
valuable that property is in the eyes of lenders... after all,
that's a much smaller portion of the property's value that still
has to be paid off.
Using your equity
In order to use your equity effectively, you'll have to use it
as collateral for a loan or a line of credit. The amount of
equity that you have available will be a major factor in the
amount of interest that you pay and the loan terms that you are
subjected to; the more equity that you have in your home, the
lower the amount of the home that's still left to be paid off
should you not make you loan payments on time.
Of course, there are a few differences between home equity loans
and home equity lines of credit... each can be used in specific
ways, and the situation that you plan to use them in can
determine which of the two is the better choice for your needs.
Home equity loans
A home equity loan is a specific amount that you borrow from a
bank or other lender and that is going to be used for a specific
purpose.
A home equity loan can be used to pay for a variety of expenses,
such as automotive financing, debt consolidation, or home
improvements, or it can even be used to refinance the mortgage
at a lower interest rate and monthly payment.
The important thing to remember is that home equity loans are of
a specific amount, so the entire amount must be paid back to
clear the loan.
Home equity lines of credit
As opposed to a home equity loan, a home equity line of credit
sets a maximum amount that can be used (based upon the available
equity) and allows the homeowner to use whatever portion of that
amount best suits their needs.
This works in much the same way as a credit card, and allows for
purchases over a longer period of time without having a specific
set amount to repay.
Home equity lines of credit are often used for home improvements
or when multiple purchases need to be made without knowing the
total cost of all of them.
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