Home Equity Loan

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When you buy a house you might contribute a down payment of anything from 5% to 20% of the total cost - or even more. If, for example, you put down 20%, as you make the repayments on the loan you gradually pay off the principal, and so you accumulate more than a 20% stake. In other words, your equity increases. Because it's yours, this equity stake is an asset, so it's worth something to you. Because you have this asset, a lender - usually a bank - may say, "If you need cash we'll lend you some money based on the equity you have in your house, which we will use as collateral for the loan." So the bank might lend you an amount equal to the equity you've built up in your home. If the house cost $100,000 and you put down $20,000 (20%), you might have increased that equity stake to 25% by your principal repayments. In addition, if the value of your home has increased from $100,000 to $120,000, because the amount you owe is unchanged, the $20,000 appreciation in value essentially belongs to you. So your equity is actually calculated as your original stake ($20,000) and repayments ($5,000), plus the $20,000 appreciation in value. This is a total of $45,000 that can be used as the basis for a home equity loan. An easy way to look at it is the current market value of the home ($120,000) minus the amount owed to the lender ($75,000). Therefore, the lender could lend you up to $45,000. As it's a loan secured by the house, it's a relatively good risk for the bank: if you default on the home equity loan, the bank can take over your stake (equity) in the house. As for you, you get access to some instant money, even though by taking out a home equity loan you take on more debt and run the risk of losing your home if you default on the repayments. A home equity line of credit is a little different. Instead of borrowing the money immediately, having the line of credit typically allows you to borrow up to the limit of the line of credit for as long as the line of credit lasts: you only access it when you need it. However, anyone taking out a home equity line of credit should read the fine print of the agreement carefully; if the borrower's property loses value or if the borrower's credit profile ( credit history) deteriorates, the lender may have the right to deny the borrower access to the line of credit. A home equity loan typically has a fixed interest rate, while a home equity line of credit usually has an interest rate that can go up or down. See also Cash-out Mortgage Refinancing and Second Mortgage, which are other ways to raise money by using property as collateral; also see Negative Equity, which is what can happen if the value of your house falls instead of appreciating.