Types of Equity Debt

2007-07-24 08:31:47

( Financial )



What is Home Equity?

Your home has a specific market value that can change over time. If you need to borrow cash, you can use your home's value as basis for the amount of the debt.

If you still have an existing home mortgage loan, the equity of your home is equivalent to the difference between the home's appraised value and the amount of principal that is still outstanding at the time. You can use this equity to acquire additional debt which you can use to finance your child's education or for home improvement projects. Equity debt also becomes handy for emergency legal or medical expenses that are otherwise not covered by any type of insurance.

Types of Equity Debt

If your home value exceeds your outstanding debts, you could qualify for two types of equity debt. An equity loan is actually a second mortgage against your property, but with less interest cost. Furthermore, you can pay as much of the loan as you wish, so that you can get back your equity. This lenient policy encourages you to borrow again sometime after repaying the equity loan.

The other type of equity debt is the HELOC or home equity line of credit. In this type of equity debt, you can draw small amounts only as you need them, until you reach the credit limit. This type of equity debt works like a credit card account.

Advantages of Equity Loans and Lines of Credit

As mentioned earlier, equity debt terms are more lenient than conventional loans. You don't incur prepayment penalties the way you do with regular mortgages, and the interest rates charged are usually lower.

Equity lines of credit can be used for short-term uses of cash, especially for transactions where you cannot pay with credit cards. You also get certain tax advantages with equity lines of credit.

Risks of Equity Debt

Despite the advantages, taking on an equity loan or line of credit pose some risks for you. Remember that you are using your own home as your collateral. So in case you are unable to service your equity loan, you could stand to lose your own home.

You also need to be aware that unlike credit cards which charge little or no annual fees, equity lines of credit require you to pay closing costs and other processing fees up front.

Your payment patterns may not also be constant, especially if you are taking on an equity debt with a variable interest rate.

The best precaution is to talk to your lender or financial adviser about the terms and conditions of equity loans and lines of credit, even before you get into the deal. Knowing what is at stake will help you make a sound decision that will not literally eat you out of house and home.


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