A home equity loan uses a borrowers "equity" in a home as collateral. The term generally refers to a loan taken out after the home has been owned for a while. The owner signs a mortgage, pledges his home as collateral, and walks away with a check. But technically, even a piggyback "second" loan, opened concurrently with a first for a new home purchase, is a home equity loan.
Then there are the Home Equity Lines of Credit, or HELOCs (pronounced just the way it looks). The difference is that you don't get a lump sum of cash. Instead you get a "checkbook" and the ability to "draw" on your home equity whenever you need cash. Naturally, the convenience comes with a costâ€”a higher interest rate. HELOCs are often referred to as "open-ended" loans while their fixed-amount counterparts (without the checkbook) are called "closed-ended."
Home equity loans were devised originally as a way to invest in home improvements, with the assumption that the money borrowed would be recovered eventually when the home was sold. But in recent years, home equity loans have financed everything from college educations to plastic surgeries.
Home equity loans and lines of credit may carry a shorter term than first mortgages. A 15-year term is common, as compared to a 30-year fixed loan. Many HELOCS are also ARMs, or Adjustable Rate Mortgages, with rates that float up and down along with some index such as the U.S. Prime Rate.
Home equity loans are "secured" by the underlying property, as opposed to credit cards which are a form of "unsecured" debt. Many homeowners have opted to refinance their higher-interest credit cards with home-equity loans or HELOCs. The lower rates and the tax deductibility of mortgage interest made the move a "no brainer," or so it seemed. But when the economy became weaker and home values dropped, their secured debt became a target for foreclosing lenders.
Conventional mortgages can be "non-recourse" loans in some states, secured only by the property itself. The lender may come after the home in a default situation, but the borrower is not personally liable. A home equity loan may be different and might be a "recourse loan" for which the borrower is personally liable. This distinction becomes important in foreclosure, because the borrower may remain personally liable for a recourse debt on a foreclosed property.