A home equity loan is a loan where the equity of the borrower’s home is used as collateral for the loan. A lien is created against the borrower’s house.
The home equity loan is sometimes referred to as a second mortgage loan, since it is common for homeowners to already have a mortgage loan with the property as collateral when they apply for the home equity loan. Generally speaking, a home equity loan tend to be for a shorter term than the first mortgage loan, but there are exceptions.
Home equity loans can be used to finance major expenses regarding the house, such as renovations and add-ons, but they can also be used to finance things that have nothing to do with the property at all, such as holidays, education or medical care. In this way, the home equity loan is more flexible than the first mortgage loan which was obtained specifically in order to purchase the home.
If you are interested in applying for a home equity loan, make sure you know all costs involved so that you can make a fair comparison of various lenders. The interest rate alone is not the only factor that will impact the total cost of the loan. Examples of possible fees and costs that may turn up are appraisal fee, originator fee, title fees, stamp duty, and application / approval fee. Some lenders will charge you a fee if you pay off the loan early.
Home equity line of credit
A home equity line of credit (HELOC) is similar to a home equity loan, but is open ended instead of close ended. A HELOC is a revolving line of credit where the home is used as collateral. The interest rate is normally adjustable.
Instead of giving you a lump sum of money and a fixed term during which to pay it back, the HELOC will provide you with a line of credit that you can utilize as you please. When you have used your revolving line of credit for a while in a responsible manner, the lender may offer to increase the limit for your available credit. This can also happen if the house used as collateral increases in market value.
There are quite a few lenders that will offer HELOC’s where the minimum monthly payment is just interest – there is no mandatory amortization as long as your home retains it value.
What is equity in real estate?
In accounting and finance, equity is the difference between the value of an asset and the cost of the liabilities of it. So, for real estate, it will basically be the the market value of the real estate minus any money owed where the real estate is collateral.
If the liabilities (amount owed) exceeds the market value of the collateral, the equity is negative.
Home equity can in increase for various reasons. Here are a few examples:
- The market value of the home goes up because of something specific to the home, e.g. a successful kitchen renovation or the addition of a home office cottage in the garden.
- The market value of the home goes up because of general changes, e.g. because the neighborhood becomes more popular than before or because of a general boost of house prices in the country.
- The home owner is amortizing on his home mortgage, making the amount owed smaller.
- The home owner is paying off his home equity loan, making the amount owed smaller.
- There used to be a tax liens against the house, but the house owner won the tax case in court and the lien was removed.