But really, what is a home equity loan?
Has this ever happened to you? You’re sitting in your friend’s newly renovated kitchen, snacking on a charcuterie board (“this Brie is delicious!”) and admiring how great their new countertops look. You’re curious how they paid for the updates. As if reading your mind, they start telling you about how they borrowed from the value of their house with a home equity loan. Apparently, it’s how they paid for the entire kitchen renovation, new backsplash and all! You have no idea what a home equity loan is, but you smile and nod politely. You’ll look it up later.
If this sounds like you, you’re not alone. The concept of a home equity loan is notoriously confusing: what are you borrowing from and how do you pay it back?
Let’s start with the basics.
What is home equity?
Home equity is the difference between how much you owe on your mortgage and your home’s value. As you pay down your mortgage, you’ll build equity in your home (and that’s a good thing!).
Here’s an example of how this might work in action:
- Original home price: $250,000
- Down payment amount: $20,000
- Total mortgaged amount $250,000 - $20,000 = $230,000.
- Amount paid so far in monthly mortgage payments: $1,100 a month x 36 months = $39,600
- Remaining mortgaged amount: $230,000 - $39,600 = $190,400
- Current home value: $290,000*
- Home equity: $290,000 - $190,400 = $99,600
*In this example, our imaginary homeowner has lived in her home for three years and her home has gone up $40,000 in value! But this will vary, depending on the housing market where you live and a variety of other factors.
What is a home equity loan?
A home equity loan is a type of second mortgage that allows you to borrow against the equity you’ve built in your home. It’s an installment loan that’s repaid on a monthly basis, similar to a regular mortgage.
Home equity loans are disbursed in a lump sum (this is what you would use for those new countertops) and typically have a fixed interest rate and fixed monthly payments. Repayment terms generally range from five to 30 years.
With a home equity loan, your home is used as collateral, so your lender can foreclose on your home if you fail to make payments. If this sounds scary, that’s because it is! But as long as you’re prepared to make on-time payments, a home equity loan can be a great way to get the cash you need for a home renovation, especially in a time when home values are higher than ever because it means you have more equity to borrow from.
