Legal Definitions - equity loan

An equity loan, also commonly known as a home equity loan, is a type of loan where a homeowner borrows a lump sum of money using the equity they have built in their home as collateral. Home equity is the portion of your home's value that you own outright, calculated as the difference between your home's current market value and the outstanding balance of your mortgage and any other liens.

With an equity loan, the lender provides the borrower with the full loan amount upfront, which is then repaid over a fixed period with regular, typically fixed-rate, payments. Because the loan is secured by the borrower's home, it often comes with a lower interest rate compared to unsecured loans, but it also means the home could be at risk if the borrower fails to make payments.

• Example 1: Home Renovation

  Sarah and Tom want to add a new sunroom to their house, a project estimated to cost $50,000. They have lived in their home for 15 years, and its current market value is $400,000, while their remaining mortgage balance is $150,000. This means they have $250,000 in home equity ($400,000 - $150,000). They decide to take out a $50,000 equity loan. The bank provides them with the $50,000 as a single payment, which they use to fund the renovation. They will then repay the loan over a set number of years with fixed monthly payments.

  This illustrates an equity loan because Sarah and Tom are borrowing a lump sum of money, secured by the equity they have in their home, to finance a specific project.

• Example 2: Debt Consolidation

  Maria has accumulated $35,000 in high-interest credit card debt and personal loans, with interest rates ranging from 18% to 25%. Her home is valued at $300,000, and she owes $100,000 on her mortgage, giving her $200,000 in equity. To reduce her monthly payments and interest costs, Maria applies for a $35,000 equity loan. She receives the full amount and uses it to pay off all her higher-interest debts. She now has one manageable loan payment at a much lower, fixed interest rate, secured by her home.

  This demonstrates an equity loan because Maria is leveraging her home's equity to obtain a single, lower-interest loan to consolidate and pay off multiple existing debts, receiving the funds as a one-time disbursement.

• Example 3: Funding Education

  The Chen family needs to pay for their daughter's first year of college tuition, which amounts to $40,000. They own their home outright, valued at $550,000, meaning they have $550,000 in equity. Rather than depleting their savings or taking out private student loans with variable rates, they opt for a $40,000 equity loan. The bank provides them with the $40,000 lump sum, which they then use to cover tuition and related educational expenses. They will repay the loan over a 10-year period with predictable monthly payments.

  This shows an equity loan in action as the Chen family is borrowing a fixed amount against the substantial equity in their home to fund a significant expense, receiving the funds as a single payment.