Home Equity Refinance - How Does This Loan Work?

It's a question many people ponder. Should home equity refinance even be considered? Well to answer the question you first have to understand what home equity is, what a home equity loan is, and what is meant by a home equity line of credit.

Equity is easy enough to understand. It's the difference between what your house and property are worth, and how much you still owe on it. Let's look at an example. You live in a house valued at $150,000. You currently owe $60,000 on your note. The equity on your home then is $90,000.

If you are getting a home equity loan, you would then be borrowing against the $90,000 you have in equity. You get the money (the amount of the loan) and pay it back much like you are paying back your mortgage, meaning monthly payments over a set period of time.

A home equity line of credit is very much like the spending limit on your credit card. You are in effect borrowing money, using it however you need, then paying it back. Let's say for example that your home equity line of credit is $8000. You decide to use $2000 of this for a down payment on a new boat. Now you will be making monthly payments on that $2000. While making those payments you see a new car that you must have. You can then borrow another $2000 for another down payment (remember you still have about $6000 left in your credit line) against the initial $8000. You will still be making monthly payments, but now those payments will be on the $4000 borrowed. If this sounds exactly like your Visa or MasterCard, that's because it is. Oh, and don't forget that you are now making payments on the boat and car as well.

Essentially you are using your house as collateral if you apply for a home equity loan or home equity line of credit. This is what makes home equity refinance too risky for some. If something happens and you fail to repay your debt, the lender in this case has a legal right to take your collateral (your home) and sell it so they can get their money back. By putting your home up as collateral the bank can be guaranteed that if you don't pay them back, they have a way to recover what they have lent.

There are many times when home equity refinance makes sense. If you purchased your house at a very high interest rate, you can refinance that loan at a much lower rate. This can literally save you thousands in interest.

It also makes sense if something has happened and your monthly payments are suddenly becoming a problem. By refinancing you may be able to get those payments down to something you can easily afford. Almost all lenders will gladly work with you if you explain the situation. Chance are they can get you a lower rate on your home equity loan, or at least work to lower your monthly payments. Loans and credit are fine, just be sure to use them wisely or you may find yourself in a situation you cannot get yourself out of.