What is a Home Equity Loan (HEL)?
A home equity loan (HEL), also called a second mortgage, is a loan secured by the equity in a house. Equity equals the value of the house less the balance owed on the homeowner's mortgage.
How Does a Home Equity Loan (HEL) Work?
Home equity loans are commonly used to finance major expenses, such as medical bills, home remodeling or a college education.
Home equity loans are very similar in concept to traditional mortgages. For example, home equity loans generally must be repaid over a fixed period. Some lenders may offer fixed rates on these loans, others might offer variable rates.
Like mortgages, most lenders will also charge points and other fees for generating the loan, and these costs vary by lender.
Common home equity loan fee types:
- Appraisal fees
- Arrangement fees
- Closing fees
- Early pay-off fees
- Originator fees
- Stamp fees
- Title fees
In some cases, the lender might charge a fee if the borrower prepays the loan. And because the loan is secured by a house, if the borrower defaults, the lender may foreclose on the house.
While home equity loans are similar in many ways to mortgages, it is important to note that they are not the same. Home equity loans create a lien on the borrower's home -- commonly second position liens -- and can reduce its overall equity. Another difference is that home equity loans and lines of credit are typically for a shorter term than traditional mortgages.
A home equity loan is also not the same as a home equity line of credit (HELOC). A HELOC is a line of revolving credit with an adjustable interest rate that allows the borrower to choose when and how to borrow against the equity of their house. Home equity loans are single, lump-sum loans with a fixed-interest rate.
Why Does a Home Equity Loan (HEL) Matter?
Home equity loans can be viable alternatives to credit cards or other high-interest, unsecured loans. Mortgage interest is tax deductible, making the interest rates on home equity loans sometimes lower than they appear when one considers the tax savings.
However, not all home equity loans are created equal. Borrowers are well served to compare fees, interest rates, and repayment terms among lenders. After all, when a borrower defaults, his or her home could very well end up belonging to the bank for good.