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Home Equity Loan
What Is a Home Equity Loan?
A home equity loan, also referred to as an equity loan, home equity installment loan, or second mortgage, is a type of loan that allows homeowners to borrow money by using the equity in their home as collateral. The loan amount is determined by the difference between the home’s current market value and the remaining balance on the homeowner’s mortgage. These loans typically come with a fixed interest rate, unlike home equity lines of credit (HELOCs), which usually have variable rates.
Key Takeaways
A home equity loan, also known as a home equity installment loan or a second mortgage, is a form of consumer debt that allows homeowners to borrow against the equity in their residence.
The loan amount is determined by the difference between the home’s current market value and the remaining balance on the homeowner’s mortgage.
Home equity loans are available in two forms: fixed-rate loans and home equity lines of credit (HELOCs).
Fixed-rate home equity loans provide borrowers with a lump sum, while HELOCs offer revolving lines of credit, allowing borrowers to withdraw funds as needed.
How a Home Equity Loan Works
A home equity loan functions similarly to a mortgage, which is why it is often referred to as a second mortgage. In this arrangement, the equity in the home acts as collateral for the lender. The amount a homeowner can borrow is typically based on a combined loan-to-value (CLTV) ratio, usually ranging from 80% to 90% of the home’s appraised value. The exact loan amount and the interest rate offered are also influenced by the borrower’s credit score and payment history.
Traditional home equity loans have a fixed repayment term, like conventional mortgages. Borrowers make regular, fixed payments that cover both the principal and interest. As with any mortgage, failure to repay the loan could result in the sale of the home to satisfy the remaining debt.
Home equity loans can be a smart way to convert the equity you’ve built in your home into cash, particularly if you use that cash for home renovations that could increase your home’s value. However, it’s important to remember that you’re putting your home at risk. If real estate values decline, you could end up owing more on the loan than your home is worth.
Additionally, if you need to relocate, you might lose money on the sale of the home or even be unable to move. If you’re considering using a home equity loan to pay off credit card debt, be careful not to run up those credit card balances again. It’s crucial to carefully weigh all your options before making a decision that could jeopardize your home.