What Is an Equity Mortgage?

The phrase equity mortgage can have several different formal meanings, as well as being used colloquially. Because of this, it is extremely important that potential borrowers are very clear about the terms on which they are borrowing. As well as referring to a standard mortgage, an equity mortgage can also refer to an additional mortgage or home-secured loan taken on when a first mortgage is partially paid off, or a type of mortgage in which the bank effectively retains part-ownership of the property.

The simplest use of equity mortgage is to describe the most basic mortgage arrangement. This is a loan, usually taken out to fund the purchase of a real estate property, in which the borrower puts a property up as collateral, meaning the lender may take possession of the property if the borrower defaults on the loan. While the term equity mortgage is used in this way in some locations, such as India, this form of loan is more generally known simply as a mortgage in the US.

An American lender offering an equity mortgage is more likely to be referring to a second mortgage or other home equity loan. These are taken out on a home that already has a mortgage, meaning both lenders have a claim on the property. To minimize risks, a second lender will normally want to make sure that the total value of the loans does not exceed, or at the very least does not greatly exceed, the value of the property.

In this situation the amount available to the borrower depends on two factors: how much he has already paid on the original mortgage, and how much the value of the property has increased since the original mortgage was taken out. These two figures combine to make what is called the homeowner's equity: the proportion of the property that he truly owns outright and cannot forfeit to a lender. A second mortgage can therefore be considered to be secured against this equity, hence the term “equity mortgage.”

A related borrowing arrangement known as a home equity line of credit may also come under the equity mortgage umbrella, though strictly speaking it is not a loan or mortgage. Instead it is a credit facility secured against the property. Rather than giving the customer a set amount of cash up front, the lender allows the customer to take out and repay money as and when she chooses. It works in a similar way to a bank overdraft, with the borrower paying interest only as and when she is using the facility.

Another form of equity mortgage is also sometimes called an equity finance mortgage. In this arrangement, there are either no interest charges, or a particularly low interest rate. Instead, when the borrower sells the property, he must give the lender a fixed proportion of any increase in the property's value: in other words the profit from selling the house. Generally this type of loan is for a proportion of the home's value, meaning it tends to be a second mortgage rather than a first mortgage designed to fund the original purchase. In most cases, the higher the proportion of the home's value the person borrows, the higher the share of any growth must be shared with the lender.