When you buy a home, you normally have to borrow in order to pay the large purchase price. While technically you own the home, the argument can be made that you don’t have a lot of value built up in it. If you were to turn around and sell the home, you would have to repay most of the money to the lender.
As you make mortgage payments, though, the amount you owe the bank decreases, and you build up value and “ownership” in the home. The value that you build up as you make payments is known as equity and gives you the option to take a home equity loan.
Tapping the Equity in Your Home
The equity in your home can be tapped in order to pay for other items. You may use a home equity loan to access the value you have built up in your home. Basically, the ownership you have in your home is used as collateral to secure your home equity loan.
Because a home equity loan is based on the value you have built up, you are limited as to the amount you can borrow. Remember: You already have a mortgage on your home, and the money is owed to your initial lender. You can only borrow against what you have “freed up” with your mortgage payments. When you get a home equity loan, you are getting another loan on your house, and you no longer have the same “ownership” that you had before.
When you get a home equity loan, you normally have two options:
Lump sum: The lender decides how much you can borrow, based on the equity you have built up in your home. You receive the total amount in one lump sum. You can then use the money for what you want. If you want more money, you need to apply for another loan.
Line of credit: Another option is to establish a line of credit based on the ownership you have built up in your home. You are given a limit, based on your home’s equity, and then you can withdraw money as you need it. This is revolving credit, so as you make payments, you free up the money to be used again.
Whichever route you take, though, you will have to pay interest, and make regular payments. With the lump sum home equity loan, you make installment payments over a set period of time. With the line of credit, you make a minimum payment each month, much like a credit card (but this one is tied to your house). Some home equity lines of credit actually come with debit cards that you can use to access your line, and make payments at registers.
What Happens if You Can’t Pay?
Because your home equity loan is secured by your house, failure to pay can trigger a foreclosure. It’s important to remember that your home equity loan is, in fact, a secured loan. Think very carefully before you decide on a home equity loan, since it can mean the loss of your house if something goes wrong and you can no longer meet your payment obligations.