What Is a Home Equity Loan and How Does It Work?

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For many homeowners, their house is their most valuable asset. A home equity loan lets you use some of that value without having to sell your home or lose your low interest rate.

What is a home equity loan?

A home equity loan is a type of second mortgage in which borrowers leverage the equity in their home as collateral. The loan amount is determined by the value of the property, typically determined by a licensed appraiser.

Homeowners often access their equity through either a home equity loan or a home equity line of credit (HELOC). A home equity loan usually has a fixed interest rate, which remains constant throughout the loan term. Borrowers receive the loan amount as a lump sum and pay it back in fixed monthly installments.

what is home equity?

Home equity is the difference between how much you owe on your mortgage and how much your home is worth. You increase your home equity as you pay down your loan balance and as the market value of your home increases.

how to calculate home equity

To calculate your home equity, first determine your home’s current market value, which may differ from the purchase price. You can use online home price estimators, but consulting a local real estate agent or licensed appraiser often provides a more accurate value.

Next, subtract your outstanding mortgage balance and any other debts secured by your home from this estimated market value. The result represents your home equity.

For instance, let’s say your home is worth $450,000, and you still owe $150,000 on your mortgage. You calculate your home equity by subtracting the $150,000 you owe from the $450,000 value. Here’s how the math looks:

$450,000 – $150,000 = $300,000

So, in this situation, your home equity is $300,000.

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How does a home equity loan work?

If you’re interested in a home equity loan, the first thing to do is figure out how much money you need. Unlike a home equity line of credit (HELOC), which allows you to draw from a line of credit as needed, a home equity loan requires you to know the total cost of your project upfront. Once you have that amount in mind, you should also calculate how much your home is worth compared to how much you owe on it.

Next, you should shop around for a lender. It’s a good idea to contact more than one lender so you can find the best interest rate and terms. When you apply for a home equity loan, the lender will determine your loan amount based on the equity in your home. You’ll receive the funds as a one-time lump sum and then make regular monthly payments that cover both the loan principal and interest over a fixed number of years.

It’s crucial to remember that a home equity loan is secured by your home, meaning your house is at risk for foreclosure if you can’t repay what you borrowed. If that happens, the lender can take your home, which could seriously harm your credit score and make it harder to qualify for future loans.

Give Loan Pronto a call if you’re ready to learn more about the home equity and refinancing options available to you. Receive a free rate quote or complete our online loan application to get pre-approved.

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