A home equity loan is a type of loan that uses the value of your home as its collateral. As you make payments on your home mortgage loan, the portion of your home that you actually own increases. In addition, if the home values in the neighborhood in which your home is located increase, the equity that you have in your home also increases. A home equity loan, also known as a second mortgage, lets you tap into your home equity and borrow against it.
In a traditional home equity loan, a bank or lender provides you with a lump sum of money which you will repay at a fixed interest rate over a set time period, often in the range of three to fifteen years. This is a shorter time frame than the repayment term for a first mortgage, which is generally repaid between fifteen and thirty years. In contrast to a home equity loan, a home equity line of credit works in a manner similar to that of a credit card: you have a set maximum amount of money that you can borrow against, the interest rate is variable, and your monthly payment depends primarily upon the amount you decide to borrow. A home equity line of credit (HELOC) allows more flexibility in the amount you borrow and pay back, but the interest rate that you pay on the outstanding balance can change over time.
There are a number of benefits to borrowing money through a home equity loan, which include:
- Lower Interest Rates. Home equity loans have a lower interest rate than many other loans, since the loan is secured by the equity in your home, posing less risk to the lender;
- Tax-Deductible Interest. The interest you pay is tax-deductible if you borrow up to $100,000, unless you use the proceeds for home improvement, in which case more interest is deductible;
- Low Loan Fees. Home equity loans usually don't have the annual fees, transaction costs, or inactivity fees that are associated with many other sources of credit;
- Flexibility. You can apply for and open a home equity line of credit, and access the money only when you actually need it.
When you are ready to apply for a home equity loan or a home equity line of credit, the first step is to talk to a reputable lender. They will be able to advise you as to what amount of money you could borrow, based on your current home's value and the amount of your existing mortgage.