What is a Home Equity Loan?

Many people have heard the term “home equity loan,” but not everyone understands what it is, or how to use it. If used correctly and responsibly, a home equity loan can consolidate and ease your debt.

As you begin to pay back your mortgage, you own more of your house, and the bank owns less. This is called building equity—equity being the percentage of the house that you own. When taking out a home equity loan, you are using the equity you have built as collateral.

“Often people understand the general idea of a home equity loan, but they don’t know the benefits of using one,” says Connie Ray, President/Owner of Coldwell Banker Platinum Partners, who explains that taking out a home equity loan is often smarter for paying off debt than other types of borrowing. The interest you pay on a home equity loan is usually tax deductible, and if you have several debts, it is sensible to consolidate them into one home equity loan. “This is a smart move because the interest rates on home equity loans are often much lower than traditional loans,” Ray notes.

There are two different types of home equity loans. Fixed rate loans offer one, large payment to the borrower, which is then repaid over time at a fixed interest rate. On the opposite end, a home-equity line of credit (HELOC) is a variable-rate loan, in which borrowers are approved for a certain limit and can withdraw money, but with a lower, tax deductible interest rate than a traditional credit card.

“Both of these types of loans can be valuable tools for responsible borrowers,” says Ray. However, it is important to understand that a home equity loan can only be borrowed for a set amount of time, generally ranging from five to 15 years.

“Similar to dipping into the cash in your savings account at a time when you really need it, taking out a home equity loan allows you to pay off a high interest credit card, send your child to college or finally put that addition onto your house,” Ray says. “However, sometimes those who are unable to budget or curb spending and find themselves in debt will take out a home equity loan as a fast solution,” Ray warns. Be aware of the reason you need to take out the loan, and never take out a loan for more than the house is worth.