How Does a Home Equity Loan Work?


Quick Answer

A home equity loan works as a second mortgage. It gives a homeowner a line of credit based on the amount of equity in his home, according to About.com. Equity is defined as a home's value minus what is owed on the mortgage. For example, if a home is worth $250,000, and the home owner has $150,000 left on his mortgage, then he has $100,000 in equity in his home.

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Full Answer

A person with equity in his home is able to apply for a home equity loan through a mortgage lender. The lender looks at the owner's credit, income, home value and other information to determine if the owner is eligible for the loan. If approved, the owner receives a lump sum of cash to be repaid in fixed monthly installments over the term of the loan.

A homeowner is also able to choose a home equity line of credit, or HELOC, that he borrows from as needed, according to About.com. Interest is applied to the loan, the amount of which is determined by the owner's credit score. Each time the owner makes a payment, part of the payment is applied to the loan's principal and part to the loan's interest. The owner is able to use the money for whatever he needs. It does not need to be spent on the home.

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