What is an Equity Loan?

Definition of an Equity Loan

An equity loan is a loan secured by real estate, where the amount of the loan is based upon the equity of the owner.

Equity is the value of the property minus any mortgages against it. If the property is residential real estate, it is referred to a home equity loan. The equity loan will almost always be a second mortgage and will not replace the first mortgage, if any, on the property. This means, in the event of default the first mortgage is paid first. You will typically need equity of at least 20% to qualify for an equity loan.

Example

Mr. McGillicuddy has a house with a fair market value of $500,000. There is a first mortgage against the house with a balance of $100,000. Mr. McGillicuddy has $400,000 in equity in the property. He needs cash but doesn’t want to sell the home. Mr. McGillicuddy can take out an equity loan, using the $400,000 as collateral for the loan.

An equity loan can be used for a number of purposes, including home renovations, repairs, bill consolidation, or other purposes. Some equity loans are a line of credit, with the borrower using portions of the loan at different times, as needed. This is known as a HELOC, for short.

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Advantages of an Equity Loan

Interest rates for an equity loan are usually lower than most credit cards, and are usually paid over a longer period of time than credit cards. Therefore, the monthly payments will be much less. In addition, there is usually a higher borrowing limit than most credit cards. Financing expensive items, such as home remodeling projects, with credit cards can become very expensive. Equity loans can make an expensive project more affordable.

Disadvantages of an Equity Loan

Since you will be carrying another mortgage payment on your home, you will have an additional monthly payment. The borrower will have to determine whether they can afford two monthly mortgage payments before obtaining an equity loan.

Depending on the size of the loan, the equity in your home will be used until the loan is paid. If you are planning on selling your present home, purchasing a more expensive home, and using your equity as the down payment on the second home, the home equity loan in place may prevent you from doing so.

If you are considering such a loan, it is best to sit down and discuss the merits and pitfalls with a mortgage professional at First Foundation, who can help in advising you the best course of action.

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Last updated Dec 12, 2018