Home Equity Loans

Homeowners use the equity in their home to get money for a variety of things. Equity can be used to for home improvements, to consolidate higher interest debts, pay for college tuition, take a vacation, or anything the homeowner chooses. There are no restrictions on how the money can be used.

Taking out a home equity loan or a home equity line of credit are the two ways that homeowners generally tap into the equity in their home. There is a difference between the two, and understanding the differences can help a homeowner make a wiser, more informed choice between the two.

A home equity loan is a fixed interest loan that is given in one lump sum to the borrower. The borrower can put the money in his own bank account to use at will. The loan is paid off monthly like a mortgage with a fixed payment of combined principal and interest. The term of the loan is usually anywhere from 5-20 years. The equity in a home is used as collateral on the loan. Therefore, if the borrower defaults on the loan, his home may go into foreclosure.

Equity in a home is something that is built over time by paying your mortgage payments and the original down payment you made on your first mortgage. The difference between the market value of your home and the amount left owing on your first mortgage is known as the equity in your home. When you have equity, you essentially have money in the bank that you can borrow against.

Most lenders see home equity loans as a pretty safe bet, although home equity loans are more risky for lenders than first mortgages are. A home equity loan is essentially a second mortgage on the property—the home itself is held as collateral for the loan and a lien is placed on the home for the amount borrowed. If the borrower defaults on payments to the first and/or second mortgage, the home can be foreclosed on (taken away) and sold to pay back the bank the money owed on the mortgage. Because of the higher risk associated with home equity loans, the term of the mortgage is shorter than the first and the interest rate is higher.

Second mortgage, home equity line of credit (HELOC), home equity loan, secured home loan, the terminology can leave your head spinning. Before we delve into the question of the day: Home Equity Line of Credit or second mortgage, it’s important to understand what a mortgage is. According to the dictionary, “A mortgage is a device used to create a lien on real estate by contract. It is used as a method by which individuals or businesses can buy residential or commercial property without paying the full value upfront. The borrower (also called the mortgagor) uses a mortgage to pledge real property to the lender (also called the mortgagee) as security against the debt (also called hypothecation) for the rest of the value of the property.” It’s a loan with real estate used as collateral.