A home equity loan or line of credit allows you to borrow money,
using your home's equity as collateral.
Wait. Don't click to another page. If the above paragraph
seems like gibberish, you have surfed to the right place. We will
explain what home equity is, what collateral is, how these loans
and lines of credit work, why people use them, and what pitfalls
First, some definitions:
Collateral is property
that you pledge as a guarantee that you will repay a debt. If you
don't repay the debt, the lender can take your collateral and sell
it to get its money back. With a home equity loan or line of credit,
you pledge your home as collateral. You can lose the home and be
forced to move out if you don't repay the debt.
Equity is the difference
between how much the home is worth and how much you owe on the mortgage
(or mortgages, if you have more than one on the property).
Let's say you buy a house for
$200,000. You make a down payment of $20,000 and borrow
$180,000. The day you buy the house, your equity is
the same as the down payment -- $20,000: $200,000 (home's
purchase price) - $180,000 (amount owed) = $20,000 (equity).
|Fast-forward five years. You
have been making your monthly payments faithfully, and
have paid down $13,000 of the mortgage debt, so you owe
$167,000. During the same time, the value of the house
has increased. Now it is worth $300,000. Your equity is
$133,000: $300,000 (home's current appraised value) -
$167,000 (amount owed) = $133,000 (equity)
A home equity loan (or line of
credit) is a second mortgage that lets you turn equity into
cash, allowing you to spend it on home improvements, debt consolidation,
college education or other expenses.
Equity loans, lines of credit defined ...
There are two types of home equity debt: home equity loans and
home equity lines of credit, also known as HELOCs. Both are sometimes
referred to as second mortgages, because they are secured by your
property, just like the original, or primary, mortgage.
Home equity loans and lines of credit usually are repaid in a shorter
period than first mortgages. Most commonly, mortgages are set up
to be repaid over 30 years. Equity loans and lines of credit often
have a repayment period of 15 years, although it might be as short
as five and as long as 30 years.