What is Equity?

• In order to take out a home equity mortgage, you must have equity in your home. Equity is defined as the difference between your home's current value and the amount you owe on the home through your mortgage and any other borrowing secured by your home. Therefore, if your home could sell for $215,000 today and you owe $140,000 on your mortgage, you have $75,000 in equity. Lenders often require that you keep 20 percent equity in your home as a cushion, so with a home worth $215,000, you would need to keep $43,000 of equity and could only borrow the remaining $32,000.
  
  

Types of Equity Borrowing

• Lenders offer two major types of home equity mortgages. The first is a home equity loan, which is an amount disbursed all at once and repaid with equal monthly payments during a fixed time period. Home equity loans generally have fixed interest rates. A home equity line of credit, also known as a HELOC, works like a credit card. During the draw period, you borrow whenever you want, up to a maximum borrowing amount of your credit limit. You make interest payments every month on the amount you have borrowed and can make principal payments if desired to free up more credit. After the draw period is over, you either make a lump sum payment of the amount borrowed or enter a repayment period with principal and interest payments. A HELOC usually has a variable interest rate.
  
  

Benefits

• Home equity mortgages can be used for any purpose, even those unrelated to your home. Although borrowers often choose to use their loans to pay for home improvement, other purposes include consolidating consumer debt, borrowing for education and paying for big-ticket items. Interest on up to $100,000 of home equity debt is tax-deductible for people who itemize deductions. Although interest rates on equity loans are higher than on most first mortgages, they are lower than those on credit cards.
  
  

Risks

• The main risk in home equity debt is that if you fail to make payments, the lender could initiate the foreclosure process. Therefore, you should carefully consider whether you can afford the payments before borrowing. This is especially important with a HELOC because you pay only interest at first, but your payments increase dramatically when you begin making principal payments as well. Plus, the interest rate on a HELOC can increase, which will further increase the payment amount. Another risk of home equity debt is that it reduces the equity you have built up in your home. If the value of your home decreases, you might even owe more than your home is worth.