A home equity loan is a mortgage taken by keeping the home equity as the collateral. It is a kind of second mortgage taken against the same property on which there is already a lien placed by a first mortgage. For example, suppose you have obtained a first mortgage worth $100,000 on your property. You have paid $50,000 in last 5 years. Your home value has also increased to $200,000 in these 5 years. So your home equity is $1,50,000 ($200,000 - $50,000). Now if you take a home loan worth $1,50,000 keeping the home equity as security for the debt, then such a loan is called a home equity loan.
Home Equity Loan Features:
- A home equity loan is offered as a single lump sum amount.
- Such loans usually have fixed rates and equal monthly payments over a long period of time, that is, 15 to 20 years. Generally the repayment period is shorter than that of primary mortgage.
- The interest rates are higher than those of primary mortgages and lower than rates offered by credit cards and auto loans.
- The interest paid on home equity loan is tax-deductible, that is, it lowers your taxable income and thus gives you the chance to save by paying less tax. The interest can be deducted for a home equity debt of $100,000.
Benefits:
- A home equity loan helps you to go for home renovation and also buy a second home.
- The loan amount can be used for expenses on education, medical treatment etc.
- A second mortgage can assist in paying off unsecured debts like credit card dues, car loans etc. It also helps to consolidate debts that are to be paid off at high rates of interest.
Disadvantages:
- Home equity loans are often used to pay off credit card debts. But this may tempt an individual to take further cash from the credit card balances, thereby increasing his unsecured debt and reducing his equity by a large extent.
- If a borrower files bankruptcy chapter 7, he can get rid off unsecured debt like credit card debt. But if he had taken a home equity loan to consolidate such debt then he will have to pay his credit card dues. This is because he had actually secured the credit card dues with his property. Otherwise he may lose his property through foreclosure on failure of repaying the unsecured loan.