In its simplest definition, home equity loan means using your house equity as collateral in order to borrow money. Collateral means your house will act as a guarantee. In the case if you cannot pay the loan or defaulted too long on payment, the lender has the right to sell the house to get back the loan.
The word equity simply means how much the house is worth minus the mortgage you currently owe.
There are two types of equity loan
1) Home Equity Loan
A home equity loan is a one off lump sum of money when you take up a loan. Usually, the loan period is between 5 to 30 years and the interest rates are fixed. The payment amount per month is fixed as well.
2) Home Equity Line Of Credit
A home equity line of credit allows you to borrow a fixed amount of money for the life of the loan. You do not need to take a lump sum loan at once since you can withdraw any amount of the loan when you need it. In a sense, it works like a credit card.
The interest rate for a home equity line of credit is variable and will rise and fall during the loan period. Payment per month depends on the total sum loaned, the interest rate and whether your credit is in the payment or draw period.
During equity draw period, you can decide whether to pay the principal loan amount or the minimum payments to cover the interest.
For equity line of credit, the loan period is usually shorter than home equity loan. Usually, it is between 5 to 15 years. During this loan period, you will not be able to increase the loan or repay the balance left in the loan. Do note, there is usually a minimum amount whether you decide to withdraw some money from the loan.
As you see, an equity loan line of credit has greater flexibility compared to home equity loan. However in both cases, if you decide to sell the house before the loan is fully paid, you are required to pay the balance immediately.
Ricky Lim works in a finance company specialising in Home Equity Loans. Visit his site for countrywide home loans rates and free home loan calculator
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