How does a home equity loan work?

I need a loan for $5000 and I own my own home. How does a home equity loan work?

The Federal Reserve defines a home equity loan as a type of second mortgage where your home serves as collateral. In this case, if you do not pay back your loan, you could lose your house. Usually, consumers get home equity loans for major items like education or medical bills. Lenders look at borrowers’ income, debts, credit history, and other financial obligations to determine how long it will take the borrower to repay the loan.

According to the International Business Times, more and more consumers are taking out home equity loans to repay their outstanding credit card debt. Applying for a home equity loan is simple. If you are approved, you receive a lump sum of the amount of the loan. Unfortunately, since your home is up for collateral, the amount you borrow is usually way more than you actually need. The home equity loan has a fixed interest rate for the number of years of the repayment of the loan. This is good because you know exactly how much you are paying each month.

Applying for any type of loan can be a hassle, and home equity loans are no exception. If you want to avoid all the paperwork, you can apply for a no doc home equity loan. Going the no doc route means you don’t have to provide check stubs and tax information to prove your income — the lender will just take your word on how much you make. Unfortunately, interest rates and payments tend to be higher with no doc loans because the fact that you could easily lie about your income means you’re a higher risk borrower.

One thing to be aware of is, since your loan amount is more than you actually need, you may feel tempted to spend the “extra” money on something like a new car. This could lead you to debt and it is a bad loan practice. Invest the money in something like a school education, or leave it in the bank. Make sure you spend that money on something that will give you something in return.