Home Equity Loans
What is a home equity loan? It is a loan or a line of credit that allows you to borrow money, putting your home's equity for collateral. It is basically a second mortgage. It allows you to turn your equity into cash to use for debt consolidation, home improvements, a college education, or other expenses.
What is collateral? Collateral is something that you use as a guarantee to your lender that you will repay a debt. If you default on the loan, the lender can take your collateral. For example, when getting an auto loan, the vehicle is the collateral. With a home equity loan, your home is the collateral. If you do not pay the loan back, the lender can force you to move out, and they can take possession of your home. They will then sell it to get their money back.
What is equity? Equity is the difference between what your property is worth, and how much you owe on it. For example, let's say the appraised value of your home is $200,000, and you owe $125,000 on it. That leaves a difference of $75,000. That is the equity in your home, which you can borrow against.
Here is a more detailed explanation of home equity loans. There are two types: a basic home equity loan and a home equity line of credit. Both can be referred to as a second mortgage, because you have used the equity in your home for collateral. Both are usually paid back in a shorter amount of time than a first mortgage. Most mortgages are for 30 years. Equity loans and lines of credit usually have a 15 year repayment period, but can be set up for as little as 5 years, or sometimes extended to as long as 30 years.
A basic home equity loan is a lump sum that you get all at once and is set up for monthly payments over a certain period of time, with a fixed interest rate.
An equity line of credit, works similar to a revolving loan, or credit card, because it has a revolving balance. It lets you borrow up to the amount of your equity, in smaller increments, over the life of the loan. You can withdraw cash as you need it, and then make monthly payments. As the loan is paid down, you can use the credit again.
A line of credit loan is more flexible than a regular home equity loan, since you can borrow just what you need, when you need it, up to the loan limit. You may elect to pay interest only and not pay the principle until the loan is due in full which is usually 5 years. The interest rate on a home equity line of credit fluctuates over the life of the loan.
With either type of home equity loan, you have to pay off the balance if you sell your home.
Either one can be a great way to get some extra money when needed, but remember, you are putting your home up for collateral, so be sure that is really something you want to do.