When homeowners are short on cash, one of the resources they may turn to is their “home equity.” On the most basic level, home equity represents your ownership in the home. If you own a home, and you have built-up sufficient equity in it, it is possible to use that equity as a source of money. But in order to benefit from the ownership in your home, you must take out a loan against it.
Home Equity Debt
There are two main forms of debt: unsecured and secured. Unsecured debt does not require collateral to ensure payment. Secured debt, on the other hand, does require collateral to ensure the repayment of debt. Home equity debt is a loan that uses the ownership in your home as collateral.
Home equity debt is a completely new mortgage on your property. It is not the same as mortgage refinancing, which replaces your original mortgage with a new home loan. Instead, home equity debt is a completely new loan that’s in addition to the mortgage you already have ― and it is smaller than your original mortgage. Home equity debt is sometimes referred to as a “second mortgage.”
There are 2 main types of home equity debt:
- Home Equity Loans (HEL): One-time loans that are repaid in installments.
- Home Equity Lines of Credit (HELOC): Revolving lines of credit based on your equity.
The equity in your home is calculated by subtracting the amount you still owe on your first mortgage from the market value of your home. If your house appraises for $190,000 and you owe $155,000 on your mortgage, you have $35,000 of equity in your home. That means you could get a secured loan for up to $35,000 (but note that most lenders will not give you a loan for the full amount of your home equity).
Most of the time, home equity debt has a term that’s between 5 and 15 years ― some loans can be had for as many as 30 years. The term length often depends on the size of the loan and your ability to repay.
The interest you pay on home equity debt is often tax-deductible, just as the interest on a regular mortgage loan is tax-deductible. The interest rate for home equity debt is also generally lower than the rate you would get with an unsecured loan. As a result, if you plan to make home improvements, consolidate debt, or go on a vacation, it may be a good idea to use your home as collateral for financing because it can save you money.
Before you take on home equity debt, it is important to remember that your home is used as collateral. If something happens and you cannot make the loan payments, you could lose your home. Because home equity debt comes with this substantial risk, it is important to carefully consider your options before borrowing against your home.