A home equity loan is a loan or line of credit that allows you to use your home or property as collateral to obtain relatively low interest rates, similar to a mortgage loan. Home equity loans can be used to fund major expenses, such as home improvements, healthcare expenses, education fees, or credit card debt relief.
Home equity loans are sometimes referred to as "second mortgages" because they are also secured against the value of the borrower's home or property. The difference between a home equity loan and a mortgage loan is that, while mortgage loans can be used to fund the initial purchase or construction of a home itself, home equity loans can only be secured against a home or property that the borrower already has equity in. The equity is the home's current value minus any amount still owed on a primary mortgage, which is the maximum amount that a borrower is allowed to borrow against.
There are two types of home equity loans. Fixed-rate home equity loans have a fixed loan amount, set payment term, and a fixed interest rate, while home equity lines of credit (HELOC) generally have a fluctuating interest rate, and the borrower can choose how much and how often to borrow against the maximum equity amount.
Home equity loans are typically shorter-term and charge slightly higher interest rates than primary mortgages. However, relative to most credit cards, home equity loans or home equity lines of credit have low interest rates and are tax-deductible, which makes them an ideal type of financing for major expenses. In addition to financing major expenses, consumers often use home equity loans to consolidate all of their debt into one monthly, low-interest payment with tax benefits.
Home equity loans are an attractive financing option for many, but it is important to also recognize the risks of borrowing against your home. You should work with a financial specialist and evaluate your equity, financial stability, and spending habits, and be sure you understand all of the terms of a home equity loan or line of credit before making any decisions.