Home Equity Loans

Definition

This is home loan that allows you to use equity built up in your home to borrow more money, even if you already have a mortgage.

Quick Summary

Are you ready for some quick math? Let's say that your home is valued at $150,000 on the market. After several years of paying down your mortgage, it is currently at $80,000. That gives $70,000 worth of equity in your home – value that you can leverage to create a second home loan. While you won't be able to borrow the full $70,000 (these loans typically only go up to 80% of your equity at the most), you will be able to acquire a significant source of capital that can be used for many different kinds of expenses or projects.

Pros and Cons

Pros

-Turning equity into cash can be very useful. Equity may look good when it comes to your personal wealth, but otherwise it doesn't have an active role in your finances. A home equity loan allows you to use that equity as fuel for more dynamic life choices or investments.

-Options for lump sums or lines of credit. A home equity loan can be with a traditional lump sum loan or a line of credit. Both are very useful in their own way. A long-term home renovation project, for example, may be better suited to a line of credit so that you can continually withdraw money for expense.

Cons

-Sometimes keeping equity is a good idea. Take a look at your debt ratio and ask, "Do I really want to turn my equity into more debt?" This isn't always the right choice for everyone's financial situation, especially if you are already dealing with a significant amount of debt from other sources (an exception may be using home equity loans for loan consolidation).

-Your home is now collateral for two loans. Those are two payments that you need to make, or otherwise risk losing your home.

What Else Should I Know?

As with most home loans, a home equity loan also depends on your personal credit history, income, and other financial factors. You can't expect the terms to be similar to your first mortgage – they will almost certainly be different. If you have any questions or additional plans to explain to your lender, do so as early as possible. Remember that you do not need to use the same lender who financed your first mortgage, although there may be some benefits in doing son.