Unless you have a few hundred thousand dollars lying around, you'll need to take out a loan to buy your first house. When you get a loan to buy a house, the house serves as collateral, meaning if you stop paying, the bank can come and take your house back. Once you've paid a certain amount of your loan back, you own that much of the house and can borrow against it.
The loan you get to buy a house is the mortgage. Before getting a mortgage, a lender usually looks at your income and past credit history to decide how much money to lend you and the interest rate for the loan. When you get a mortgage, you typically agree to make a monthly payment for a set number of years, usually 15 or 30, though other terms are available, until the mortgage is paid off.
Home Equity Defined
The equity on your home is the difference between how much you still owe on the mortgage and how much your house is worth at the moment. If you buy a $250,000 house with $25,000 down, right away your home equity is $25,000. Over time, as you make payments towards your principal and your house increases in value, your equity in the house will rise. In some instances, if the value of the house has risen, your equity can be more than what you paid for the house. You could also end up with negative equity if the value of your house goes down from the time you purchase it and you owe more on the mortgage than the house is currently worth, according to Bankrate.
Basics of a Home Equity Loan
A home equity loan is essentially another mortgage on your house, as you are borrowing money against the value of your home and against what you've already paid. When you take out a home equity loan, you receive a single payment for up to the total value of the house's equity. You do not need to borrow the entire amount of the equity on your home. You then need to repay the loan much as you did the original mortgage, by making monthly payments. The repayment period for a home equity loan can be between 5 and 30 years. You can have a home equity loan at the same time as your original mortgage.
The interest rate you pay on a home equity loan is usually higher than on a first mortgage. For instance, as of September 30, 2010, the interest on a fixed-rate home equity loan averaged 7.15 percent, compared to 4.5 percent for a 30-year fixed rate mortgage, according to Bankrate. Unlike with a mortgage, you do not have the option of choosing a variable rate on a home equity loan.
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- Bankrate: Home Equity Basics
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