What Are Home Equity Loans?

People who are faced with financial difficulties may have to turn to lending facilities for relief. Equity loans may be one solution for those who would fit the qualifications for such a loan.

However, it is not simply a matter of filling out an application for an equity loan with the first loan agent that pushes an offer. Getting any type of loan in haste can put a borrower in what would otherwise be an avoidable disadvantage. Having a good understanding of what is a home equity loan is very important before considering availing of one.

Home equity loan defined

Finding a proper equity loan definition is as easy as doing a quick search on the Internet. Let us first define equity. As most commonly used in real estate, the term equity is simply the amount remaining when you subtract the unpaid balance of a loan from the actual current value of an asset.

Assume for example that the purchase value of a house is $100,000. It was paid for with a downpayment of $10,000. A balance of $90,000 is owed in mortgage. The following year a partial payment of $5,000 was paid bringing down the balance owed to $85,000. However, for that year the property was appraised for $110,000. The equity now stands at $25,000 ($110,000 less $85,000).

If the owner of the house applies for an equity loan, it will be based on the value of the equity of the property. In other words, a home equity loan is primarily cash borrowed using the equity value of the home as collateral.

Usually, home equity loans are granted as a percentage of the equity value. Following our above example, if a lending institution approves a home equity loan up to 80% loan to value (LTV), that would equate to $20,000 (80% of $25,000).

Equity loans as a second mortgage

In most cases, home equity loans are made available to home owners even if the original mortgage has not yet been fully paid. In these scenarios, a home equity loan acts as a "second mortgage" on the property and is secured by the property. This means, if the home owner fails to pay the equity loan, the house can be sold by the lender to settle the debt.

It is therefore crucial for homeowners to fully understand the terms and conditions applicable to equity loans before signing up for one. Otherwise, they may end up without a roof above their heads.