Home Equity Loan: What is it & How to get one

By Lauren Leisk, Yahoo7 Moneyhound Updated October 18, 2012, 9:00 am

What is a home equity loan?

A home equity loan gives you access to the equity in your home to use as collateral for another investment loan, or if you plan to renovate, or if you need spare cash. In simple terms, a home equity loan gives you access to the capital gains of your property without having to sell the house.

What is home equity?

Whether you are considering an investment property or looking for a family home, most buyers are willing to invest in a house and mortgage in order to reap some rewards from equity and capital gains in the future.

But if you already have a home loan and your property has increased in value since its date of purchase, you may be lucky enough to already have some equity. This equity can be used for further investments.

Your home equity is the current value of your property minus the amount you owe.

How to work out the equity in your home

For many buyers, the equity in their home might only be realised when they come to sell their property. If your home has gone up in value when you sell, your equity will come as leftover cash once you pay out the remainder of your home loan and mortgage.

However, many investors begin to use their accumulated property value through home equity loans and line of credit lending.

For example, if your home is worth $400,000 and you owe $250,000 on your home loan, you have amassed $150,000 of equity that could be used as a cash investment on new investment projects. That $150,000 could be the missing amount that gets you into the investment property market while using very little from your own savings.

If you think your house has gone up in value, the equity of your property could be used to secure a new home equity loan. Banks and lenders simply consider the equity in your home as collateral for the new loan.

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What are home equity loans for?

The equity in your home could be used to relieve financial stress elsewhere including medical costs, repairs, education costs or holiday bills. However, savvy investors often use cash from home equity loans to make down payments on further properties.

If your home equity loan is being used for investment, you might consider an interest-only period where you pay only the interest due to make your repayments more manageable. Although this may make repayments easier, this will also prolong the life of your loan should you not be on-selling.

Interest on your investment loans may also be tax deductible, including home equity loans.

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How do you get a home equity loan?

Your lender may have limits on the home equity amounts they can lend, similar to regular borrowing limits on home loans. But if you are approved for a home equity loan, borrowing will work in a similar way to accessing funds through a credit card.

If you have a separate line of credit for your new loan, you may consider putting the funds into an offset account to save on mortgage interest while the money is idle. This can be particularly useful for investors who are building and will access funds in stages as their project progresses.

With the old saying “you need money to make money”, you may find a home equity loan can unlock some cash funds you hadn’t previously considered were available to access and re-invest. However borrowers beware, it's never wise to increase your debts to unmanageable proportions. These examples use all available equity, and just because you have equity doesn’t mean they can afford the interest repayments if you plan to borrow against it.

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