The basic definition of a home equity loan emphasizes its two main elements -- it's a loan secured by your home, in which you tap into the equity you have built up. A home equity loan is a popular financing option for a variety of homeowners.
Equity means net worth. In a property, it is the difference between the current value of your home and the amount you still owe on a mortgage loan. An equity loan is essentially money borrowed against your property's net worth. Taking on a new loan does decrease your equity, so if you were to sell before paying down the loans, your portion of funds from a sale are reduced.
Secured by Home
The other key factor of a home equity loan is that it's secured by your property. You grant the lender a lien on your property similar to the one held by your first mortgage lender. This is the lender's protection in exchange for providing you access to equity funds. If you fail to repay your loan, the lender has a right to claim possession or funds from a foreclosure sale.
A main reason homeowners opt to use home equity is the normally lower interest rates than those available through personal loans or credit cards. Borrowers sometimes use equity to consolidate high-interest-rate credit cards, which can save significantly on interest. Plus, the interest paid on home secured loans is usually tax-deductible, whereas personal loan and credit card payments aren't. The repayment on a home equity loan is also typically structured with fixed payments over a period of time, such as three to five years.
The major downside or risk of a home equity loan is that your property serves as collateral. You add an additional lien holder and have a higher debt obligation tied to your house. In the worst-case scenario, a lien holder could foreclose or seek judgment on your property if you fail to repay your debt. Also, while the loan repayment is structured, you do have to mess with a regular monthly installment, which can lead to budget or cash-flow issues. An equity loan of $35,000 to $50,000 means at least a few hundred dollars in additional monthly payments.
- Ablestock.com/AbleStock.com/Getty Images