Home equity loans are a way of using the money that you've invested
in your mortgage by borrowing against it. Essentially, a home
equity loan is a 'second mortgage' - a loan secured by your property.
If you don't make good on your payments, the lending company
or bank can force the sale of your house to recover their money.
There are two types of home equity debt: home equity loans and
home equity lines of credit, also called HELOCs. Both are sometimes
referred to as second mortgages, because they are secured by
your property,
just like the original, or primary, mortgage. A home
equity loan for $10,000 and a home equity line of credit for
$10,000 are two completely different animals though they have
a lot of similar features.
Home Equity Loan
If you apply for and are granted a home equity loan for $10,000
at 7% APR for 15 years, you will receive a check or a deposit
to your bank account of $10,000. That is the full amount of the
loan that you can ever draw on that particular application. Depending
on the terms agreed upon, you may have one to several months
before you have to begin repaying the loan. You'll pay a fixed
amount every month until the full amount of the loan and the
interest charge is paid off. You'll know from the very start
how much you'll be repaying.
Home Equity Line of Credit
A home equity line of credit - a HELOC - is much more like a
credit card. When you apply for and are granted a home equity
line of credit, the bank establishes a 'line of credit' - which
functions just the way that a 'credit limit' does on your credit
card. You may receive special checks or a plastic card with which
to access your line of credit - but you don't receive the full
amount at one time.
In fact, you don't have to take any of it immediately. You can
draw on the line of credit at any time, up to the full amount
of the line of credit throughout the agreed-upon life of the
loan. Suppose that you're doing some home repairs. You can use
your home equity line of credit to pay for $2,000 worth of roofing
tiles. That leaves you $8,000 in your line of credit. Three weeks
later, you can use your line of credit to pay for $4,500 worth
of windows - and still have $3,500 left that you can borrow against.
If you then start paying back on your home equity line of credit,
that money becomes available to you again. If you pay back $1,000
of what you've borrowed, you now have $4,500 on your line of
credit.
A home equity line of credit has two 'phases' - there is the
draw period, during which time you can draw against the credit
limit as long as you stay below the limit. During that time,
you can elect to only pay the interest that accrues - or you
can make payments on the principal to free it up. Once the draw
period is over, you go into the repayment period. During the
repayment period, you can't draw against the line of credit any
longer, and must make full repayment.
