Home loans, including mortgages, home equity loans and cash-out refinances, are an essential force in the real estate market, and the economy in general. Federal regulations influence the housing market by controlling how lenders manage home loans, and by offering financial relief, including bankruptcy reorganization, for borrowers in danger of foreclosure.
For home buyers, the primary purpose of a loan is to facilitate the purchase of a house or to finance the construction of one. A home is the biggest investment most people will ever make, and few private individuals could afford one without a mortgage. Mortgage loans give borrowers with good credit histories access to lower interest rates and make it affordable to own a home within the two or three decades that the loan takes to pay off.
Home loans can also fund home improvements, which are very important for homeowners. Home improvement loans are usually a wise investment because they add value to a home, some or all of which will be realized when it comes time to sell. Home improvement loans can also save borrowers money by allowing them to pay for necessary repairs as needed, rather than waiting to save up money and finding that the damage is worse and the repairs more expensive that they would have been earlier.
Second mortgages, which include home equity loans and home equity lines of credit, and cash-out refinance loans give homeowners access to money for home improvements, medical bills, college tuition or other expenses, based on the equity built up by paying off the original mortgage. All of these loan types use home equity–the amount the borrower has already paid against the initial mortgage–to give the homeowner access to cash.
A home equity line of credit is a loan that the borrower can dip into as needed, making charges periodically. A home equity loan and a cash-out refinance loan both give the homeowner an up-front lump sum payment. While a home equity loan exists as a second mortgage alongside the first mortgage, a cash-out refinance replaces the original mortgage and may also give the borrower access to a new, lower interest rate.
For lenders that provide home loans, including mortgage banks and most large commercial banks, home loans serve as a means of earning a profit. Lenders charge interest based on a borrower’s degree of risk. In addition, some lenders require certain borrowers who represent a higher risk to purchase mortgage insurance, which protects the lender in case the borrower is unable to pay back the loan. Lenders use home loan interest to pay stock dividends, to pay interest to depositors and to fund other corporate activities.
Home loans have an important purpose in the global economy. Besides helping to pay for the employment of bank staff, home builders and real estate agents, home loans also fuel mortgage-backed securities. These are investments that earn money based on homeowners paying interest to lenders. Investment banks and other firms use mortgage-backed securities to distribute investments across the economy. The money that homeowners borrow against home equity also goes into the general economy, paying for goods and services that borrowers might otherwise have gone without.