Home Equity, Equity Loans and Line of credit
Equity is the difference between how much the home is worth and how much you owe on the mortgage in other words the current market value of a home minus any outstanding mortgage balance or liens. Home equity is the amount of ownership that has been built up by the holder of the mortgage through payments and appreciation. Typically, residential property is bought through a mortgage, which is then paid off over a number of years. After the mortgage has been fully repaid, the property then belongs to the mortgagor, namely the buyer.
Let's say you buy a house for $200,000. You make a down payment of $20,000 and borrow $180,000. The day you buy the house, your equity is the same as the down payment -- $20,000: $200,000 (home's purchase price) - $180,000 (amount owed) = $20,000 (equity).
House purchase price: $200,000
Amount borrowed: -$180,000
Down payment/equity: $20,000
Fast-forward five years. You have been making your monthly payments faithfully, and have paid down $15,000 of the mortgage debt, so you owe $165,000. During the same time, the value of the house has increased. Now it is worth $300,000. The $100,000 increase in value raises your equity by $100,000. Your equity is now $135,000: $300,000 (home's current appraised value) - $165,000 (amount owed) = $135,000 (equity).
Five years later
Amount borrowed: $180,000
Principal paid: -$15,000
Amount owed: $165,000
House's appraised value: $300,000
Amount owed: -$165,000
Equity $135,000
Home equity loan
A home equity loan or line of credit is a second mortgage that lets you turn equity into cash, allowing you to spend it on home improvements, debt consolidation, college education or other expenses.
Equity loans and lines of credit...
There are two types of home equity debt: home equity loans and home equity lines of credit, also known as HELOCs. Both are sometimes referred to as second mortgages, because they are secured by your property, just like the original, or primary, mortgage.
Home equity loans and lines of credit usually are repaid in a shorter period than first mortgages. Most commonly, mortgages are set up to be repaid over 30 years. Equity loans and lines of credit often have a repayment period of 15 years, although it might be as short as five and as long as 30 years.
Home equity loan
A home equity loan is a one-time lump sum that is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan.
Home equity line of credit
A home equity line of credit, or HELOC, works more like a credit card because it has a revolving balance. A home equity line of credit is defined as getting a loan by using the home’s equity as collateral. A HELOC allows you to borrow up to a certain amount for the life of the loan, a time limit set by the lender. During that time, you can withdraw money as you need it. As you pay off the principal, you can use the credit again, like a credit card.
Let's say you have a $20,000 line of credit. You borrow $10,000 to pay for home improvements. At that point, you owe the $10,000 you borrowed, and you have $10,000 remaining in your credit line, meaning that you could borrow another $10,000.
Instead of borrowing more from the line of credit, you pay back $5,000. At this point, you still owe $5,000, and you have $15,000 in available credit.
Line of credit: $20,000
Amount borrowed: -$10,000
Available credit line: $10,000
Amount paid back: +$5,000
Available credit line: $15,000
A HELOC gives you more flexibility than a fixed-rate home equity loan. It also is possible to remain in debt with a home equity loan, paying only interest and not paying down principal.
A line of credit has a variable interest rate that fluctuates over the life of the loan. Payments vary depending on the interest rate, the amount owed and whether the credit line is in the draw period or the repayment period.
Draw Period
The equity line's draw period refers to the number of years over which you will repay this equity line of credit. The draw period often is five or 10 years, and the repayment period typically is 10 or 15 years. Each lender can set its own draw and repayment periods. Lenders have been known to have draw periods of nine years, six months. A line of credit is accessed by check, credit card or electronic transfer ordered by phone. Lenders often require you to take an initial advance when you set up the loan, withdraw a minimum amount each time you dip into it and keep a minimum amount outstanding.
Repayment Period
The repayment period is a period when new borrowing cannot take place, and the balance must be repaid over the remaining life of the loan typically over 20 years. The repayment period, expressed in years, begins after the 'advance' period has ended. Usually, you will be required to make payments of principle and interest in order to retire the line of credit.
With either a home equity loan or a line of credit, you have to pay off the balance when you sell the house.