subject: How Does A Home Equity Loan Work? [print this page] A home equity loan, or second mortgage, is a loan taken out by a homeowner in addition to the first mortgage they have on the property, if they have one. A borrower can still take out a home equity loan if there are no other liens on the property.
A home equity loan, being a second lien is riskier than a first mortgage in that if the borrower defaults on the property, the holder of the home equity loan gets paid after the holder of the first mortgage. This is why rates are higher on home equity loans than on first mortgages.
Some home equity loans, specifically home equity lines of credit are often interest only, and have a term when they either have to be either paid off or refinanced. The rates on a home equity loan might be either fixed, or variable, as the rate on a first mortgage might be.
The process to obtain a home equity loan works much like it does in obtaining a conventional first mortgage. The borrower applies for the home equity loan and provides the lender income and asset information.
Once the information to apply for the home equity loan has been taken and credit has been run, a review is made, and the lender will let the borrower know if they qualify for that home equity loan. Home equity loans, as first mortgages do, require appraisals before they can be fully approved, and that is the next step.
Borrowers looking to take out a home equity loan will be limited to a percentage of the value of the property. In the days of more loose lending, home equity loans went up to 100% of the appraised value of the property.
Now, the lenders that do write home equity loans are much more conservative, some staying at or below an 80% combined loan to value (CLTV). This means that if the maximum that they would allow their home equity loan to be would be the difference between the value of the first mortgage and 80% of the appraised value.
An example calculating the maximum home equity loan value will help explain this. Let's say that the property appraises at $200,000 and the maximum ratio the lender will go up to is 80%, or $160,000. If there is a first mortgage for $120,000. The maximum home equity loan that the lender will allow is $40,000, or $160,000 less $120.000.
