What Is a Home Equity Loan?

When it comes to financing major repairs and other expensive home projects, doing so can be exceptionally difficult.

More often than not, people require loans in order to complete such projects, yet the details associated with obtaining one can be exceptionally confusing at times.

Home equity loans aren't exactly as straightforward as most people would like. When you put in the time to learn how they work, though, things become far less of a headache.

To put it simply, a home equity loan is a form of loan in which the homeowner uses his or her home as collateral.

While they are often used to finance home repairs, they can also be used to pay for college education, medical bills and more—essentially, for any large expense that would be difficult to pay off otherwise.

Taking out one of these loans will create a lien on your home and actually reduces the home's equity.

What many people often get confused about is the fact that a home equity loan and a home equity line of credit (HELOC) are actually two different things.

With a home equity loan, the funds are paid out in a lump sum—it's a one-time thing.

In addition, you cannot borrow on the loan again in the future the way you often can with a home equity line of credit.

For these reasons, one of the two may be a better fit than the other depending upon your situation.

Home equity loan rates

There are a few basic things to know about home equity loans and how they might impact you.

The first aspect to understand is the rate.

The interest rates associated with home equity loans tend to be fixed, meaning that the payments you make on a monthly basis will also be fixed.

Most people like the stability that comes along with a fixed interest rate and fixed payments, as it can make budgeting much easier than it might be otherwise.

Add to this the fact that interest paid on home equity loans is typically tax deductible, and it's possible to actually save on the interest being paid in the end.

Qualifying for a home equity loan

To qualify for a home equity loan, you'll have to have a few logistics in place.

For one, the amount you owe on your home must be less than its actual value (you have to have available equity in order to borrow).

Most lenders will allow you to borrow 85% of the value of your home or less (subtracting the amount you actually owe), although this can vary dramatically depending upon the situation.

When determining whether or not you qualify for a loan, the lender will take into consideration your credit history, monthly income, current debts and so on.

Typically, qualifying for a home equity loan requires you to have very good credit, although some lenders may be willing to make an exception for those whose history is less than stellar.

Home equity loan features

There are a number of different features associated with home equity loans, some of which can vary depending upon the lender.

You should also keep in mind that fees can be accrued for simply getting the loan off the ground (application and appraisal fees, for example).

On the positive side, some lenders offer discounts for automatic payments, which is also a great way to ensure that you stay on track with your payments each month.