Before a person takes out a home equity loan, he or she should understand what equity is and why money is borrowed against it. For starters, equity is the amount of money that builds up as a home gains value. As an example, if a person purchased a home at fair market value for $120,000 and ten years later, that same home could be sold on the market for $180,000, the property has $60,000 in home equity, money that belongs to the owner.

However, regular homeowners build home equity simply by buying and living on the property. While the properly would likely increase to some degree, the more the homeowner upgrades the property, making improvements, the greater the value would ultimately be. Even if a person purchased a home for $120,000 and went to sell it but could only get $125,000 out of the property, if that person had been in the home for many years, then the balance would be paid down. Therefore, the homeowner might only owe $80,000 on the loan loan so if the home were sold at the fair market value of $125,000, he or she has home equity of $45,000 even though the sell price would be only $5,000 more than the original purchase price.

Now, certain factors come into play that would have a direct impact on the amount of home equity a person has. For instance, if the homeowner took out a home improvement loan, otherwise known as a second loan, that would have to be deducted from the equity. For this, if the homeowner had a home that could sell for $160,000 and the first loan could be paid off at $100,000, there would be $60,000 remaining. However, if the second loan against the home were $40,000, the true home equity in this scenario would only be $20,000, not $60,000.

The interesting thing about home equity is that it could work for or against the homeowner. Often, people will take out a home equity loan, which means borrowing money against the free money built up. While there are situations when a home loan such as this makes sense, there are also times when it could be disastrous. A home equity loan is very much like a first fast cash payday loan in that the homeowner would have to go through the entire loan process again to include closing and all associated costs. In addition, how the money is spent could be good or bad.

Although money from a home equity loan could be spent in whatever way the homeowner deems, if not careful, the person could end up needing money for a very serious expense but have nothing on which to draw. In this case, if the homeowner had $60,000 and took most of it out in the form of a home equity loan to take a lavish, extended vacation, what happens if a family member were to become ill or injured and a significant amount of money was needed? With the home equity being used up, the family would be faced with a very difficult situation.

This is why many lenders of home equity loans only loan a certain percentage of money coming from the equity. This way, the homeowner could still take the extended vacation wanted but because money would still be untouched, if something unforeseen were to arise, there would be options. Most often, a person that takes out a home equity loan is looking to have the home repaired or remodeled, perhaps to buy a better running car, or as a means of paying off high interest credit card debt and consolidating bills. Again, when used the right way, home equity can work for the homeowner but if not, it could work against the homeowner.

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