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One of the scariest things about a home equity loan is that the lender has permission to sell your house if you fail to keep up with repayments. In exchange for loaning you a big lump sum of cash, the financial institution is granted a legal claim on your property and the right to take possession of it to recoup what it’s owed. In other words, once you sign on the dotted line, you are technically a slip up away from becoming homeless.
Key Takeaways
- With a home equity loan, the lender can sell your house if you don’t keep up with repayments.
- As long as you keep paying back your loan as agreed upon, you never lose your home equity. However, if you default, your lender can lay claim to your property.
- When you completely repay your home equity loan, you remove the lender’s interest in your property and regain your home equity.
Using Home Equity to Get a Loan
Home equity loans are loans based on home equity, which is the value of the portion of your home you actually own. To calculate your home equity, you take the appraised current worth of your house and subtract from that figure any outstanding mortgages on it. What you are left with is the dollar value of your ownership stake in your home.
Home equity grows when you make mortgage payments and when your house appreciates in value. Once you have built up a certain amount of it, generally at least 15% to 20% of your home’s value, you can use it to get a home equity loan or home equity line of credit (HELOC).
Home equity loans give homeowners the option 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 that the lender can sell it to recoup what it’s owed if you fail to keep up with repayments. For example, if you default and still have an outstanding loan balance of $15,000, the lender is legally able to sell your home to recoup that $15,000.
When Do You Get Your Home Equity Back?
As long as you keep up with repayments, you never lose your home equity. The lender only has a claim to it if you default on the loan. When a home equity loan is taken out, a lien is placed against your property. This lien makes it known to the world that somebody else has a legal claim on your house and can take ownership of it if an underlying obligation, such as the repayment of a loan, is not honored.
Liens are attached to loans to protect the lender in the event that the borrower is no longer able to pay it back. They basically give creditors peace of mind that they’ll have another way to retrieve what they’re owed 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 repaid in full, the lender’s interest in the property is removed, and your home equity becomes yours again.
When a lien is in force, either through a first mortgage, second mortgage, or both, the borrower’s title over the property is legally not clear, and they technically don’t have complete ownership of it.
Special Considerations
Giving a financial institution permission to kick you out of your home if you don’t pay its loan back is not something to take lightly. It is, however, part and parcel of home equity loans and mortgages in general, and it can actually work to your benefit if you have no issues meeting your financial obligations.
Offering your home as a guarantee makes the loan less risky. With your property on the table, the lender has a claim to something of value that it can seize and sell, if necessary, to retrieve the outstanding balance. The loan is secured, and this added protection translates into lower interest rates, effectively reducing the amount you are charged to take out the loan.
It’s also worth stressing that the lender can only kick you out of your house and sell it if you renege on the agreement and fail to fulfill your contractual obligations. As long as you keep up with repayments, the house remains yours, and the lien is harmless.
Does Paying Off a Loan Increase Equity?
Yes. As you pay off your mortgage, the amount of equity you hold in your home will rise. The other notable way home equity increases is when your house grows in value and your ownership stake in the property becomes worth more.
Can You Take Equity Out of Your House?
Absolutely. There are several different types of products that enable homeowners to turn their home equity into cash. Other than home equity loans, two other common solutions are HELOCs and cash-out refinancing.
What Is the Monthly Payment On a $150,000 Home Equity Loan?
That depends on a variety of factors, including the length of the loan and all associated charges. As a basic example, a $150,000, 30-year home equity loan with a fixed interest rate of 5% would carry a monthly payment of $805.23
The Bottom Line
The thought of becoming homeless because of one missed payment is enough to put anyone off taking out a home equity loan. It’s good to think that way and be aware of the repercussions whenever borrowing money. Your house is at stake, so committing 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 helpful if used in the right way. The Great Recession reminded the public about the dangers of extracting capital from home equity, but it also created some misconceptions.
One is in regard to the risk of foreclosure on a second mortgage. Though lenders have the right to foreclose if you default on the loan, it is generally seen as a last resort, because the lender of the first mortgage must first be paid off completely. Second mortgage lenders get the leavings, and so they are often willing to negotiate with cash-strapped borrowers rather than wind up with only part or none of their money being returned.