What is A Home Equity Loan and How Does it Work?

Your mortgage serves as a security for a home equity loan. In some instances, you have the choice to use as much as you want. This loan type has become very popular in the past few years as it offers flexibility to borrowers. Homeowners now have access to relatively cheap and competitive loan packages too.

Using the equity you have in your current home loan you will be able to:

  • Purchase another property
  • Renovate your house
  • Pay back your loan
  • Buy a boat or a car
  • Take care of medical expenses
  • Meet wedding expenses
  • Use for holidays
  • Invest in the stock market
  • Use it for lifestyle expenses

 

Cash Out Policy

Some people don’t always use the borrowed money for its intended use. This is why most of the lending institutions proceed with caution when they assess the application for equity loan approval, especially if they do not have sufficient evidence of why a borrower needs the money.

A number of banks have a cash out policy in place to limit the amount of cash you can use between $10,000 and $15,000. However, there are some other lenders who do not impose such restrictions. Despite having those policies in place, it’s important to take responsibility and release the equity for the same purpose as outlined to the bank.

 

Is an Equity Loan the Right Choice?

It is only advised to take out an equity loan if you have the discipline to manage your expenses properly. There are so many people who spend the entire amount on lifestyle expenses, but do not devise a plan on how to pay it back.

You can release the cash of up to 80 percent of your property value. Some banks allow you to use the cash up to 90 percent of the property price, but for that, you should pay a one-off lender’s mortgage insurance premium.

 

Line of Credit – The Best Option?

Banks prefer a line of credit (LOC) over a home equity loan, because the interest charged is higher compared to a standard loan. However, a better option is to go for a 100 percent offset home loan as it offers better features with a comparatively lower interest rates. This loan type also makes it easier for you to manage your cash. It allows you to redraw or keep it in the offset account, to keep the day-to-day expenses separate from available equity.

 

Consolidating Debt

One of the key reasons why borrowers release home equity is to put it towards their unsecured loans by converting them into minimal monthly repayments. Normally, interest rates towards a credit card are between 10 – 30 percent and between 9 – 15 percent for personal loans.

 

Low Doc Home Equity Loan

It is not easy to release your equity with a low doc debt, because financial institutions do not have evidence of your salary. They also don’t know where you intend to use the funds. Therefore, you can release equity of up to 60 percent loan to value ratio (LVR) with a low doc equity loan. A few banks also allow 80 percent (LVR), but with a high interest rate.

 

Factors to Keep in Mind when You Apply for Home Equity Loan

The following are some of the things you have to keep in mind when applying for home equity loans:

  • With a line of credit, you can access the equity through any ATM, which can make it hard to spend the money in a disciplined manner. If you think create possible financial problems, it is recommended to go for the 100 percent offset home loan.
  • Once you consolidate your debt, do not issue personal loans or open more credit cards after that. If you keep consolidating your debt, it might lead you into a downward spiral and you will be stuck with a heavy amount of debt by the time you retire.
  • If you have bought a house in the past two years, it is less likely to release equity. Therefore, always consult your mortgage broker and calculate the amount of equity you have.

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