Home equity debt, which is also referred to as a home equity loan or second mortgage, is a loan received by using equity in a home as the required collateral. While home equity debt can sometimes provide advantages over other forms of debt, such as credit cards, it can put a home owner in danger of losing the collateral property if he or she defaults. Some homeowners use home equity debt to finance home repairs, pay off high interest debt, or liquidate assets in emergency situations.
Home equity is accrued by making payments on a property; as a person works toward paying off a mortgage, he or she gradually begins to legally own more and more of the value of the home. Home equity is an asset, but not an easily tapped one; a homeowner can't trade in square footage of his or her house for a loan, for instance. In order to liquefy equity, a homeowner can borrow against the owned percentage of his or her property, creating home equity debt.
Two of the major reasons that homeowners create home equity debt are favorable interest rates, and the possibility of tax deductions. If a homeowner has a good credit history and stable finances, he or she may be able to secure a second mortgage at a lower interest rate than a credit card of the same value. The terms on repaying home equity debt may also be extended far longer than with other types of debt; up to 30 years in some cases. Home equity debt can also be advantageous because the interest paid on the debt is tax-deductible in some cases, which can actually save homeowners quite a bit of money if they have high taxes.
The biggest downside to home equity debt is the possibility of losing the home to default. When home equity debt is used as collateral, that may give the lender the right to seize the home if the borrower defaults, even if he or she declares bankruptcy. If a person loses his job and can't make payments on the second mortgage, the house could be seized, even if payments on the initial mortgage are still manageable. Financial experts often recommend setting up several layers of contingency plans and emergency funds before taking out a home equity loan.
Home equity debt may be taken out on an open-ended or closed system, depending on the structure of the loan. An open-ended loan works like a line of credit, allowing the borrower to withdraw, repay, and reuse the money repeatedly. A closed debt is a one-time lump sum that is repaid over time until the balance is restored. Closed home equity debts may be preferable in some cases, as they allow the borrower to begin building equity again as soon as the debt is repaid.