In the consumer finance world, an equity loan typically refers to a type of financing that is based on the difference between the value of an asset and any outstanding liens or claims against that asset.
By its very definition, an equity loan is a secured loan. The loan amount is limited by the available value of a collateral asset, which is also used as security for the loan. Equity loans are commonly associated with real estate and mortgage financing products, such as home equity loans or home equity lines of credit (HELOC). In rare cases, an equity loan may be associated with certain car title loans, which are also based on the available equity and value of a vehicle.
A mortgage equity financing typically takes the form of a revolving line of credit or an installment loan that provides a lump sum of cash issued to the borrower. The revolving line of credit is often called a HELOC, short for home equity line of credit. The balance of an equity credit line can vary based on the amount borrowed and paid against the credit limit, and it works much like a credit card.
In a home equity loan, the home equity lender will appraise the subject property to determine its current market value. A real estate appraisal is a report estimating the real property’s value, usually based on a physical inspection of the premises and research that includes a comparison of recent real estate sales transactions involving similar properties in the area.
The lender will also identify any outstanding liens on the property, to determine how much equity is available in the property.
For example, suppose a home is valued at $300,000 and there is an existing mortgage balance of $200,000. This leaves $100,000 in equity available to the borrower.
The home equity loan provider can then provide equity financing with a credit line or home equity loan of up to $100,000 – subject to other restrictions and eligibility.
If the property owner receives a line of credit, that borrower usually receives a checkbook that will allow him or her to access the $100,000 credit line at almost any time and without having to get additional approval from the lender. In this example, the home equity line of credit acts much like a credit card. If the borrower accesses any part of the credit line and maintains a balance, the owner can then make regular payments toward the outstanding equity loan balance or pay off the equity loan in full – much like a credit card. The borrower will also be able to make multiple, separate withdrawals against the credit line, so the balance and monthly payments can fluctuate.
The standard home equity loan provides a lump sum cash payment to the borrower in the form of an installment loan. The equity loan is then paid off through amortized installment payments, until the loan is retired.
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