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How Home Equity Loans Work

You are able to borrow money from your home, depending on how much equity you have. Your financial institution will determine the amount of available equity. Some financial institutions will loan up to 100% to 125% of this value, although 70% to 80% is more common.

Throughout this website, we will describe the following aspects involved in obtaining a home equity loan: What is collateral, how do home equity loans work, how is a line of credit determined, why would you want to use a home equity loan, and what are the problems to avoid.

Let's first discuss collateral:

Collateral is an asset that is pledged to guarantee the repayment of a debt. Should a person be unable to repay a debt, for any particular reason, the lender will require the forfeiture of the collateral. The lender will then sell the asset, typically by auction, to recover the amount of money loaned to you.

This is where a Home Equity Line of Credit comes in. You are pledging the equity in your house, as collateral, to secure the lender's interest. Should you be unable to repay the home equity loan, the lender will force you to move out of your home and it will be liquidated to recover the amount you borrowed.

Your home equity

Is the amount of difference between the appraised value of your home, less the amount of mortgage or mortgages you have on your property.

For example: You purchase a house for $150,000. Your down payment is $15,000 and you borrow $135,000. On the day you close on your property, the equity is the equal to the down payment of $15,000: $150,000 (purchase price) minus $135,000 ( amount financed ) equals $15,000 (equity).

Lets look ahead five years.

Let us assume you have made your regular monthly payments, $135,000 @ 5% for 30 years, and have been able to pay down the principal, from income tax returns, bonuses, etc. an additional $15,000. Your current mortgage balance would be $109000 (approximately).

Now remember every year that you own your home the appraised value will increase, so lets say the current appraised value of your home is $200,000. Your current equity is $91,000: $200,000 (current appraised value) minus $109,000 ( amount owed) equals $91,000 ( equity )

It is this increased equity that would now be available to borrow as a Home Equity Loan.

Please move on to our other articles for the rest of the story.

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