Home Equity Loan
A Home Equity Loan is a type of loan in which the borrower utilizes the equity in their home as collateral. Typically these types of loans are taken out by the consumer to pay for repairs, home improvements, or as a way of consolidating their consumer loans and credit cards. It will create a lien on the property just as a 1st mortgage does. In most cases a Home Equity Loan will be a 2nd lien, but can sometimes be a 3rd lien.
Because these liens are often in 2nd or 3rd position, one must have good credit history and equity in their home to minimize risk to the investor. For example, if homeowner goes into foreclosure on their home, the liens are paid back in the order that they are listed on Title, so the farther back the line is, the less likely it will ever be paid back if the homeowner stops making payments.
There are 2 main types of Equity Loans, one is the Closed End Home Equity Loan, and the other is an Open End Home Equity Line of Credit otherwise known as a Home Equity Line of Credit or HELOC.
Closed End Home Equity
These types of Equity Loans are fixed rates and the borrower will receive a lump sum. The loan is typically amortized over 30 years, but will be required to be paid back in 15 years as a balloon mortgage. The payments consist of interest and principal and are constant throughout the life of the loan. Even if you pay a large portion down, one cannot draw back on this type of loan because it is a Closed Line.
Open End Home Equity Loan Of Home Equity Line Of Credit (Heloc)
These types of Equity Loans are revolving lines that can be drawn on as they are paid down. They are tied to the Prime Index and usually have a Margin attached to them. The better the credit score and lower the Loan-to-Value, the lower the margin. The rate is calculated as follows: (Prime of 5.250% as of 04/14/08 + Margin of 1.000 = Fully Indexed Rate of 6.250%. However your Margin can be negative, such as -1.000 if the borrower's credit is strong and the Loan-to-Value is low. Open-End Equity Loans are repaid based on interest only payments and are only paid down if one makes larger payments towards principal each month, much like a credit card.