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An equity loan is a loan that is made based on collateral. The collateral for an equity loan consists of money already put into an existing debt. Most commonly, the equity loan is based on home equity, which means that the new loan relies on money that the borrower has already put into a real estate mortgage. A home equity loan is usually based on the primary residence of the borrower, although in some cases, an investment property can also serve as collateral.
Various types of home equity loans are offered to families and individuals by a wide variety of lenders, both large and small. Home equity loans are often regarded as secured loans, because the property acts as collateral. Similar deals, called reverse mortgages, also allow for the homeowner to effectively take money out of their mortgage to get more cash for paying current bills.
Different types of home equity loans work in different ways. A conventional home equity loan involves the lender releasing a set amount of money, with the borrower agreeing to pay it off over a certain time frame. On the other hand, a home equity line of credit, or HELOC, works differently. In a HELOC, the borrower essentially gets a line of credit against home equity, which is a kind of revolving debt that works much like a credit card. The borrower charges amounts to their home equity line of credit, paying them off as the possibility arises, against a maximum credit amount.
Consumer advocates urge borrowers to know what they are getting into with all of the home equity loans that lenders offer them. One of the biggest issues is the interest rate attached to a home equity loan. Since these loans include collateral, interest rates should be lower than they would be for some other types of loans based on a borrower’s credit score. It’s up to the borrower to read the loan agreement carefully, and understand how the interest rates will affect the money that they pay over the term of the loan.
Borrowers also need to look at fees and costs associated with an equity loan. Origination fees and other costs, including broker or representative commissions, often get blended into the entire loan value. This is another case where the borrower must read the agreement very carefully and understand what they are signing. Knowing more about the home equity loan, and other types of equity loans, will help households and individual consumers make the right decisions about taking on additional debt.