Home Equity Loans: Information and FAQ

What is a Home Equity Loan?

A home equity loan — also known as a second mortgage, term loan or equity loan — a mortgage lender lets a homeowner borrow money against the equity in his home. In other words, the amount of the loan is partially based on how much home equity — the difference between the value of your home and how much you owe on the mortgage(s) — the homeowner has.

An example may help illustrate: Let’s say you own a house now valued at $300,000. You put down $30,000 when you bought it and have paid down $30,000 in mortgage principal. You would have $60,000 in equity ($300,000 value of home – $240,000 still owed = $60,000 in equity) in the home. The lender would use this equity number — in addition to your credit score and income — to determine how much of a loan you will get (typically homeowners can get up to roughly 85 percent of the equity in their home). The longer you pay down the mortgage and the more your home appreciates in value, the more equity you build up in the home and the larger a home equity loan you may qualify for.

Just beware: You are putting up your home as collateral on the home equity loan, so if you do not pay it off, the bank can take your home.

How Do Home Equity Loans Work?

If you get a home equity loan, you will receive the entire amount of the loan all at once (as opposed to a home equity line of credit, which works more like a credit card, where you take just what you need when you need it). Often, you have to pay off a home equity loan within about 15 years, though the terms vary. The interest rate on the loan is typically fixed.

What Can a Home Equity Loan Be Used For?

You can use a home equity loan for most anything you want. Many people use it to do repairs or upgrades on their homes, pay for their kids’ college or pay off high-interest debt (often, the interest rates on these loans are much lower than rates on credit cards, so this can make financial sense if you’re careful).

Who Should Consider a Home Equity Loan?

If you need a lump sum of money for something important (such as a home repair, not a vacation or something fleeting) and are sure you can easily repay a home equity loan, it’s worth considering. The rates on a home equity loan tend to be significantly lower than rates on credit cards, so this can be a more economical option than paying for what you need with plastic. And sometimes the interest paid on home equity loans is tax deductible, so this may be an added financial bonus (talk to your tax advisers, as this varies).

Just remember, you will get all this money in one lump sum (so make sure that makes sense for you, rather than an option such as a home equity line of credit, where you can take out the money little by little), and you can lose your home if you don’t repay the loan.