In real estate, a homeowner can borrow against the equity they have built up within their home. Equity equals the value of an asset, minus any liabilities (such as the loan amount still owed). So, if you purchased a home worth $250,000 and have paid your mortgage for several years, paying off $50,000, then you have $50,000 of equity in your home.
Example
$250,000 asset value - $200,000 still owed = $50,000 equity
Home Equity Loan
A home equity loan is a loan in addition to the original mortgage and the equity is paid out in a lump sum. Often a home is refinanced so a Home Equity Loan replaces the original mortgage, and a cash-out amount is provided to the borrower for the equity line of credit. The funds can be used by the borrower for any purpose: home renovations, college tuition, paying off student loans or other debts, purchasing a vehicle, etc. The loan is repaid in monthly installments over a set term with a fixed APR.
A home equity loan is essentially a large line of credit with your home as collateral. Some of the benefits of opting for a home equity loan over a personal loan are:
The opportunity to borrow more than a personal loan may allow.
The interest payments, like your regular mortgage, can be tax-deductible.
Lower interest rates—because your loan is secured (with the home as collateral), borrowers can qualify for a lower interest rate than an unsecured loan (credit card).
The length of the loan is often longer than a private loan, affording you more time to repay the loan.
Home Equity Line of Credit (HELOC)
Similarly, a HELOC borrows against the equity of the home and is a separate loan from your mortgage; they are not “lump sum” loans. Rather, they work more like credit cards with a rolling credit balance, which can provide more flexibility over time than a home equity loan.
The funds borrowed can be used for any purpose; common uses include large, scheduled payments that occur over months or even years—like tuition payments or payments to a contractor for renovations. As a bonus, you only pay interest on the amount of credit you actually use, not the full amount you are provided. So, if you have a home equity line of credit of $25,000 but use only $12k, then you will only be required to pay interest on the $12k and not the full $25k.
