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Home Equity Loans – Apply Today

So, you are considering a home equity loan as a way to liquidate some of your home's value. You probably have a lot of questions about the process, or else you wouldn't be reading this article right now. So let's jump right into the world of home equity loans and lines of credit.

How an Equity Loan Works

If you've owned a home for more than a few years, you've probably been approached by lenders with a home equity loan offer. But how do these loans work, and how can you use them for your own financial purposes?

With a home equity loan (or a line of credit, to be discussed later), you are borrowing a certain sum of money by using your equity as collateral. This leads to another necessary definition. Equity is the portion of the home you actually own, based on the payments you've made thus far.

Let's say your home is worth $300,000 and your mortgage balance (the unpaid amount) is $200,000. In this scenario, you have about $100,000 worth of equity in the property. This is the amount most lenders will loan you through this type of process. So theoretically, you could apply for a home equity loan or line of credit for the owned amount $100,000.

Loan vs. Line of Credit

People use the terms home equity "loan" and "line of credit" interchangeably, but they are slightly different versions of the same concept. With the loan strategy, you are given a lump sum amount that you'll pay back in regular payments (much like your original mortgage loan).

With a home equity line of credit (or HELOC), you are given a line of revolving credit that you can draw on periodically and pay back much like a credit card. In both cases, equity is the common denominator -- you will always be borrowing against the owned portion of your house.

Common Uses for Home Equity Loan

How you use the money you gain through this process is up to you. Some of the most common reasons homeowners use this financing option include:

• Debt consolidation (primarily for high-interest credit cards, etc.)
• Financing education costs
• Major home improvement / renovation
• Financing a second home purchase

When to Avoid It

If you are a financially responsible person, and you have the ability to make your equity loan payments on time, then this could very well be a useful financing tool for you. However, if you even suspect you'll have trouble paying back the home equity line or loan, then you should avoid it. The last thing you want to do is use your home as collateral for a loan you cannot repay. It's a surefire recipe for losing your home.

In that regard, home equity loans are like many other types of financing -- there are smart ways to use it, and foolish ways to use it. For the responsible homeowner, this type of loan could be a quick source of cash with an interest rate lower than other forms of consumer credit. For the irresponsible borrower, it could be a one-way ticket to foreclosure.

Equity Stripping and Other Scams

Unfortunately, there are plenty of "companies" out there who seek to take advantage of homeowners through a variety of home equity loan scams. Your best defenses against such predators are common sense and homework. Don't ever rush into a home equity loan or line of credit plan until you have thoroughly researched the company who is offering it.

Some of the most common scams in this arena include:

Equity Stripping - This is a scenario where the lender helps you "pad" your stated income on the application form in order to qualify. Why would they do such a thing? Because they don't care about your ability to actually make the payments -- they will simply foreclose on your home and benefit from the equity you've built up. The best defense here is to make sure you can afford the payments on a home equity loan.

Loan Flipping - This is a scenario where the lender offers you a second home equity loan after you've already obtained one loan (and made a few payments on it). The lender will refinance your first equity loan and loan you the additional money. Of course, they will also charge high points and fees with each new loan. There's also a good chance they'll increase your interest rate too. Homeowners who fall prey to this scam often get in over their heads with all the fees that stack up on them. It's a good way to lose your home.

The Contractor Scam - If a home improvement contractor (such as a roofer) ever tells you they can "hook you up" with a lender to finance your improvement project, tell them to take a walk. This is a common scam used to rope people into home equity loans without their realizing it.

This is not meant to scare you away from this financing method, but merely to make you more cautious. There are plenty of reputable lenders who will give fair terms on a home equity loan or line of credit. You just have to be smart when pursuing such a program.

My advice is to use a company you've heard of before -- somebody who has been around for a long time and has a reputation to protect. Most of the scams are perpetuated by companies the borrower had never of before.

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About the Author Brandon Cornett is a real estate writer and the publisher of Home Buying Institute. He has been educating consumers on housing-related topics since 2004.