A home equity
loan or line of credit allows you to borrow
money, using your home's equity as collateral.
Wait.
Don't click to another page. If the above
paragraph seems like gibberish, you have surfed
to the right place. We will explain what home
equity is, what collateral is, how these loans
and lines of credit work, why people use them,
and what pitfalls to avoid.
First, some
definitions:
Collateral - is
property that you pledge as a guarantee that you
will repay a
debt. If you don't repay the debt,
the lender can take your collateral and sell it
to get its money back. With a home equity loan
or line of credit, you pledge your home as
collateral. You can lose the home and be forced
to move out if you don't repay the debt.
Equity
-
is the difference between how much the home is
worth and how much you owe on the mortgage (or
mortgages, if you have more than one on the
property).
Example: Let's
say you buy a house for $200,000. You make a
down payment of $20,000 and borrow $180,000. The
day you buy the house, your equity is the same
as the down payment -- $20,000: $200,000 (home's
purchase price)
- $180,000
(amount owed) = $20,000 (equity).
Fast-forward five years. You have been making
your monthly payments faithfully, and have paid
down $13,000 of the mortgage
debt, so you owe
$167,000. During the same time, the value of the
house has increased. Now it is worth $300,000.
Your equity is $133,000: $300,000 (home's
current appraised value) - $167,000 (amount
owed) = $133,000 (equity)
A
home
equity loan (or line of credit)
is a second mortgage that lets you turn equity
into cash, allowing you to spend it on home
improvements,
debt consolidation, college
education or other expenses.
Mortgage Glossary3
