One of the scariest things about a home equity loan is that the lender has permission to sell your home if you can’t keep up with the payments. In exchange for lending a large sum of money, the financial institution obtains a legal claim to your property and the right to take possession of it to recover what is owed to it. In other words, once you’ve signed on the dotted line, you’re technically one step away from becoming homeless.
Key points to remember
- With a home equity loan, the lender can sell your home if you don’t meet the repayments.
- As long as you continue to repay your loan as agreed, you will never lose the equity in your home. However, if you are in default, your lender can claim your property.
- When you fully pay off your home equity loan, you remove the lender’s interest in your property and regain your home equity.
Use home equity to get a loan
Home equity loans are loans based on home equity, which is the value of the part of your home that you actually own. To calculate the equity in your home, you take the estimated current value of your home and subtract from that figure any outstanding mortgages on it. What you’re left with is the dollar value of your share of ownership in your home.
The equity in your home increases when you make mortgage payments and your home increases in value. Once you’ve accumulated a certain amount of it, usually at least 15-20% of your home’s value, you can use it to get a home equity loan or a home equity line of credit (HELOC).
Home equity loans give homeowners the ability to use the equity in their property as collateral to borrow a lump sum of cash. When your home is used as collateral, it basically means the lender can sell it to collect what’s owed to them if you fail to keep up with the repayments. For example, if you default and still have an outstanding balance of $15,000, the lender is legally able to sell your home to recover that $15,000.
When do you get your home equity back?
As long as you follow the repayments, you never lose the equity in your home. The lender is only entitled to it in the event of default. When a home equity loan is taken out, a lien is placed on your property. This lien lets the world know that someone else has a legal right to your home and can take possession of it if an underlying obligation, such as loan repayment, is not honored.
Liens are attached to the loans to protect the lender in case the borrower is no longer able to repay it. They essentially give creditors peace of mind that they will have another avenue to collect what is owed to them if the debtor runs into financial difficulty and stops settling the debt.
The lien remains in place until the debt is extinguished. Once the home equity loan has been paid off in full, the lender’s interest in the property is removed and the equity in your property becomes yours again.
When a lien is in effect, whether through a first mortgage, second mortgage, or both, the borrower’s title to the property is legally unclear and technically he does not have full ownership of it.
Giving a financial institution permission to evict you from your home if you don’t repay their loan is not something to be taken lightly. However, it is an integral part of home equity loans and mortgages in general, and it can really work to your advantage if you have no problem meeting your financial obligations.
Offering your house as collateral makes the loan less risky. With your property on the table, the lender has a claim to something of value that they can seize and sell, if necessary, to recover the outstanding balance. The loan is secured and this extra protection translates into lower interest rates, reducing the amount you are charged to take out the loan.
It’s also worth pointing out that the lender can only evict you from your home and sell it if you back out of the deal and fail to fulfill your contractual obligations. As long as you follow the repayments, the house remains yours and the lien is harmless.
Does repaying a loan increase equity?
Yes. As you pay off your mortgage, the equity you hold in your home will increase. The other notable way to increase your home equity is when your home goes up in value and your stake in the property is worth more.
Can you withdraw equity from your home?
Absolutely. There are several types of products that allow homeowners to turn their home equity into cash. Besides home equity loans, two other common solutions are HELOCs and cash refinancing.
What is the monthly payment for a $150,000 home equity loan?
It depends on a variety of factors, including the term of the loan and any associated fees. As a basic example, a 30-year $150,000 home equity loan with a fixed interest rate of 5% would result in a monthly payment of $805.23.
The thought of becoming homeless because of just one missed payment is enough to deter anyone from taking out a home equity loan. It’s good to think this way and be aware of the repercussions when borrowing money. Your house is at stake, so to commit without fully understanding the terms is foolish.
It’s important not to be too scared, though. Loans can be dangerous, but they can also be very useful if used correctly. The Great Recession reminded the public of the dangers of extracting capital from home equity, but it also created misconceptions.
One is the risk of foreclosure on a second mortgage. Although lenders have the right to foreclose if you are unable to repay the loan, this is generally considered a last resort, as the lender of the first mortgage must first be fully repaid. Second mortgage lenders get the leftovers, so they’re often willing to negotiate with cash-strapped borrowers rather than end up with only some or none of their money paid back.