Equity is the difference between your home's value and the balance on your mortgage loan. If your home is worth $100,000 and you owe $75,000 on the mortgage, then you have $25,000 of equity in your home.
Borrowing against this equity is currently a very popular method of getting a big chunk of credit, primarily because of low interest rates. Add to that the fact that the interest on most home equity loans is tax deductible and they become an appealing option if you need to make a major purchase.
Home equity loans are typically used for consolidating consumer debt or covering a large expense such as a big wedding, college tuition, or home renovations.
However, because your home is collateral for the loan, you should be very careful about using home equity loans. The problem is that if you default on the loan, the bank will foreclose on your home.
Types of Home Equity Loans
There are two types of home equity loans. A traditional home equity loan is also called a second mortgage and is when a bank lends you a lump sum of money that must then be paid back over time. With this type of home equity loan, interest begins building as soon as the bank issues you the money.
A newer type is a home equity line of credit, where a bank gives you a checkbook or credit card to make purchases, which then accrue against your home's equity. With this type of home equity loan, interest does not begin building until you actually make a purchase.
There are also several ways to repay a home equity loan. The most common option is to make regular payments toward both the interest and the principal.
However, some loans also give you the option of only paying the interest at the beginning of the loan and gradually paying more of the loan and gradually paying more of the principal. Finally, you may have the choice to pay both principal and interest, but to make extra payments in order to pay off the principal sooner. You should check with your lender about this, as some loans have penalties for paying ahead."