Are All Equity Loans Equal?

Pretend: The wedding day of your loving and lovely daughter finds her eyes streaming with hot tears and her mouth cursing your name. The reason: The catering check bounced and that elegant 30-tier cake is being airlifted out. For many homeowners, an equity loan provides a much-needed spike in cash flow, whether to settle outstanding accounts, refurbish the homestead, or just have your cake and eat it too.

Home equity loans and home equity lines of credit offer homeowners a financial viable opportunity to consolidate debts, unlock cash, or pay off existing high-interest loans. But how do equity loans and lines of credit work? How much can be withdrawn from a home? And, what are the average interest rates associated with equity loans?

Unlocking capital through a home equity loan or home equity line of credit begins with the appraisal of collateral (i.e. the home, itself). Most lenders allow consumers to borrow up to 90% of the appraised value of equity minus the remaining amount owed on the mortgage. For instance, if your home has an appraised value of $200,000, the largest loan possible would be $180,000. If $50,000 is still owed on the mortgage, $130,000 would be the maximum allowable equity loan or line of credit.

A home equity line of credit represents funds at a borrower's disposal-not necessarily funds already withdrawn. Opening an equity line of credit doesn't expressly indicate that all available funds will be used. As such, the interest calculated for lines of credit depends heavily on the amount of principle borrowed. Ordinarily, lenders will entice homeowners with low initial interest rates-in some cases Prime + .5%. Providing an excellent opportunity to consolidate high interest debts, many consumers borrow extensively against their credit line; subsequently, banks and lenders raise interest rates to sometimes as much as Prime + 4.75%. The chief benefit of a home equity line of credit is the ability to control cash flow. Oftentimes consumers find a home equity loan too much or too little; a line of credit allows for a great deal of flexibility in this area.

The interest rates for most home equity loans are fixed; meaning that lenders cannot suddenly increase rates. While largely contingent upon credit history, 7.5% is a standard starting interest rate (assuming impeccable credit rating) on home equity loan. Although considerably higher than a 30-year fixed home mortgage loan (6%), a home equity loan provides for considerably lower interest rates than most credit card loans (15-18%), making equity loans an attractive option for consolidation of debt. Interest payments, in addition, are oftentimes tax deductible.

The three most important considerations of equity loans or lines of credit are credit history, collateral, and existing debt. Lenders will closely examine all these factors before agreeing to an amount or interest rate. Credit history, when applying for any type of loan, is a major concern. Any credit anomalies (forfeited debts or bankruptcies) must be explained before a reputable bank will issue a loan. Bad credit does not always exclude consumers from loans, but will always create higher interest rates and additional provisions.

Collateral simply refers to the equity staked to the loan. Lenders want the property appraised and need to know of any remaining mortgage payments, since if you default on the home equity loan, the lender will repossess the property.

If existing debt (house and car payments, credit cards) chews up too much gross income, many lenders will shy away from issuing lines of credit or equity loans, despite the presence of collateral. Before meeting with the lender, make sure to review your current debt situation and calculate the ratio of debt to income. Be prepared to answer any concerns a lender might have in reference to proffering you a loan. The same is true with credit history; know your credit rating and be able to explain any problems.

After all, securing a home equity loan or line of credit is no piece of cake-it could spell the whole thing.