What is a home equity loan?

Written By ADITYA

It is a loan secured by the equity in your home. It means that a bank could let you borrow up to 75% or 80% of the equity in your home (the difference between the home’s market value and the outstanding loan balance on your home).

There are two types of home equity loans: closed-end credit and open-end credit

1. With an open-end home equity line of credit, you can borrow up to a pre-determined credit limit on a revolving charge account.

2. With a closed-end home equity line of credit, you borrow a fixed amount for a set period of time. A closed-end home equity line of credit is the same as a second mortgage on a home.

What are the advantages of a home equity loan?

1. Interest charges on home equity loans up to $100,000 may be taken as an itemized deduction on federal income tax returns. (In contrast, the interest payments on other types of consumer loans are not deductible.)

2. Home equity loans are usually available at lower interest rates than other consumer loans and repayment can be stretched out over a longer period.

What are the disadvantages of a home equity loan?

Borrowing against the equity in your home might encourage you to become a “borrower” instead of a “saver.”

If you default on a home equity loan, you could lose your home.

If your ATM card is stolen, a thief could withdraw the entire balance of your home equity loan if the loan can be accessed through your checking account.

Use this worksheet to help you shop for the best deal

Federal Reserve Board. Comparison shopping for a home equity loan.http://www.federalreserve.gov/pubs/riskyhomeloans/worksheet.htm

This worksheet will help you compare:

  • monthly payments,
  • Annual Percentage Rate (APR),
  • possible changes in the interest rate,
  • the cost of points,
  • fees for the loan application, appraisal or other fees,
  • number of years to repay the loan,
  • the possibility of a balloon payment,
  • closing costs,
  • penalty for late or missed payments, and
  • cost of credit insurance.

How can you protect yourself against losing your home when using a home equity loan?

  • Read all items carefully. It might be helpful to consult an attorney to be sure that you understand all of the terms and conditions of the loan.
  • Keep records of billing statements and payments.
  • If credit insurance is included in the loan, ask that the charge be removed. If you want credit insurance, shop around for the best rates.

What is a home equity conversion mortgage (HECM) for seniors?

  • This is also known as a reverse mortgage.
  • It can be used by homeowners age 62 and older to convert the equity in their home into a monthly stream of income or a line of credit to be repaid when they no longer occupy the home.
  • This loan is funded by a mortgage lender, bank, credit union or savings and loan association.
  • Consumers who want to use this type of loan should receive education and counseling from a Housing and Urban Development (HUD) approved HECM counselor.
  • Call 202-708-1112 to learn about your nearest HUD office.

What are the requirements of a home equity conversion mortgage (HECM) for seniors?

  • Homeowners 62 and older who have paid off their mortgages or have only a small amount remaining, and who are currently living in the home.
  • A HUD reverse mortgage does not require repayment as long as the home is the borrower’s principal residence.
  • Lenders recover their principal, plus interest when the home is sold.
  • Generally, the more valuable the home, the older the homeowner, the lower the interest, and the more the homeowner can borrow.
  • Homeowners are charged an upfront insurance premium which is 2% of the maximum claim amount that may be borrowed plus a .5% annual premium.


Federal Reserve Board. Comparison shopping for a home equity loan.

Federal Deposit Insurance Corporation. Putting your home on the loan line is a risky business.

Federal Trade Commission. Home Equity Loans: Buyers Beware. http://www.ftc.gov/bcp/edu/pubs/consumer/homes/rea11.shtm

Housing and Urban Development (HUD). About reverse mortgages for seniors – Section 255 – Home Equity Conversion Mortgages.

Checklist for using a home equity loan

1. Review other possible sources before borrowing against the equity in your home.

2. Repay the home equity loan as soon as possible.

3. Remember to include interest charges as expenses in your income tax calculation.

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