After you obtain a loan and buy a house, you’ll hopefully build up some equity in the home. Equity is the difference between what you owe on your home and what the home is worth. For example, if you put $20,000 down on a $120,000 home, you’ll owe $100,000 on your house.
If the home is still worth $120,000, then you have $20,000 equity in your home. The hope is that while you’re paying down the loan each month, your home value stays the same or increases. That way your equity (stake) in the home increases.
Eventually, you may find a need for a large sum of money. Funds you can use for education, a vacation, debt consolidation, home improvements, etc. To get those needed funds you may be able to tap into your home equity.
There are two primary loan vehicles used for this- a home equity loan and a home equity line of equity (HELOC).
The both use your home as collateral.
So, what’s the difference?
Home Equity Loan
These are sometimes referred to as a second mortgage and can even be a third mortgage. Qualifying for these is much harder than a first mortgage. Credit scores usually need to be 660 or more.
You determine how much of the equity you want to borrow but it’s usually capped at around 90% or even less of the home value. Let’s say your home is worth $200,000. Ninety percent of that is $180,000.
Now, say you owe $120,000 on the home. At 90% of your home value, you’ll be able to borrow $60,000. That’s the difference between what you owe ($120,000) and 90% of the value of your home ($180,000).
Note: You total equity in the home is actually $80,000. That’s the difference between what you owe, $120,000 and what the home is worth, $200,000. However, lenders will seldom provide an equity loan for the total home value.
Home equity loans are usually fixed rate. You pay them back pay via a payment plan just like your first mortgage.
In general, you use a home equity loan for the following reasons:
Home Equity Line of Credit (HELOC)
A HELOC provides you access to a line of credit. You can use this as you need it. You usually can use as much or little as you like up to the HELOC limit. So, in the example above, you’d get access to $60,000. You can take that $10,000 at a time or $500 at a time until the limit of $60,000 is reached.
You pay interest charges only on the amount you use. So, if you borrowed $20,000 right away, you’d pay interest on the $20,000 only not the full $60,000 HELOC. As you pay off your balance, your HELOC is replenished. However, you’re only required to pay back the interest.
The interest on both the Home Equity Line of Credit and the HELOC may be tax deductible which is another advantage for you.
You might consider a home equity line of credit for the following reasons:
More information on Home Equity Loans and HELOCS
The Federal Reserve’s website is an excellent source of government information on these loans: