Getting a Loan: What Is a Home Equity Loan?

Getting a Loan: What Is a Home Equity Loan?

A home equity loan is one of many different types of loans a person can take out. This type of loan requires the use of an owned home as collateral for the loan.

When a person buys a house, he or she generally pays a down payment and then uses a mortgage loan to pay for the rest of the purchase price. Over a period of time he or she will pay a mortgage payment to the lender each month in order to eventually pay off that loan.

However, there are many instances in which a person finds he or she may need to adjust his or her loan or borrow additional money for something like a home renovation, major repairs or something like hospital bills and children's educations. One option for homeowners who end up in a situation like this is to take out a home equity loan.

What Is a Home Equity Loan?
A home equity loan is a type of loan where a person uses his or her home's equity as collateral to take out a loan. This kind of loan is often called an equity loan or a second mortgage. The equity of a home is the difference between what the home is currently worth and what a person has paid or has left to pay on his or her mortgage loan.

When a home is purchased, the loan amount is generally the purchase price of the home, minus any down payment the purchaser made initially. For example, if a home is for sale for $300,000 and the buyer pays a down payment of $25,000, he or she will take out a loan for $275,000. After a period of a few years, if that person has made continuous, timely mortgage payments, the amount of the remaining debt will go down.

If, after eight years, the buyer of the $300,000 home needs to take out a home equity loan, he or she will need to figure out the following: How much his or her home is currently worth, how much of the initial mortgage loan has been paid and how much debt is left. If the home is appraised at $325,000 and the initial $275,000 loan has been paid down to $139,000, that leaves $136,000 left to be paid off. In this situation the home's equity would be $189,000; the amount of the home's appraised value minus the amount left to be paid on the original mortgage loan. Therefore, this home own has $189,000 worth of equity in his or her home that can be used as collateral to take out a new loan.

Taking Out a Home Equity Loan
The next question is how a person obtains this type of loan. Generally, the homeowner will talk to the same bank or lender that he or she worked with for his or her initial mortgage loan. Doing this is easier partly because the lender of the mortgage loan is already familiar with the person's financials, including if they make payments on time and information regarding the house the person owns and wants to use as collateral. Once it is determined that the homeowner is eligible for a home equity loan, he or she will need to have the home appraised in order to figure out its value and what equity is available to be used to take out the loan.