A home equity loan -- also known as a second mortgage, equity mortgage or equity loan -- allows a homeowner to borrow money against the equity in their home. The amount of the loan will be based, in part, on how much equity the homeowner has, which is the difference between the value of the home and how much the homeowner owes on the mortgage.
For example: if you own a home valued at $300,000 and owe $240,000 on your mortgage, you have $60,000 in equity. A lender will use this amount of equity, along with your income and credit, to determine how much you qualify to borrow. Most homeowners can get up to 85% of their home equity.
When you get a home equity loan, you will receive the full amount of the loan at once. This is one of the main differences between a home equity loan and a home equity line of credit (HELOC), which works a bit like a credit card, giving you access to a line of credit based on your home equity.
You typically need to pay off a home equity loan within 15 years, and the interest rate is usually fixed. With a HELOC, you will usually get an adjustable rate. An equity loan may be used to pay for home improvements, medical expenses, college education and more. The interest paid on a home equity loan is tax deductible.
However, be careful about using a home equity loan to purchase consumer goods, as the loan will use the home as collateral and are subordinate to an existing mortgage. If you default or do not abide by the loan terms, the lender may foreclose on your home . The home equity lender also has the right to protect its interests. If you stop paying on your first mortgage, the second position lender may make payments to the first lender and begin foreclosure proceedings.
If you need a large sum of money for something important, such as making home repairs or paying for college, and you have the ability to repay the loan, a second mortgage is worth considering. Rates tend to be very low, and significantly lower than a credit card interest rate, so many homeowners turn to an equity loan to pay off high-interest debts and consolidate them into a single, fixed interest rate and monthly paymentBecause the interest you pay is tax deductible, this can serve as an added bonus.
If you do not need a large amount of money all at once, or you prefer to have access to your equity in case of an emergency, it may be a better idea to consider a home equity line of credit (HELOC) instead. With a HELOC, you will not need to repay anything unless you borrow money, and you will always have the line of credit available if you need it, much like a credit card.