A home equity loan, or HEL, is secured by the equity in a person's home. Proceeds from a HEL may be useful for financing high-cost expenses such as medical bills, college education, or major home repairs or remodeling. Depending on state statute and lending institution policy, up to 100 % of the equity may be borrowed. Equity in the house is reduced accordingly.
HELs may be negotiated as either an open-end or closed-end loan. An open-end HEL is a line of credit loan, or HELOC. A closed-end loan is the traditional, second mortgage-type loan.
With a closed-end HEL, the borrower receives a lump sum amount and cannot borrow additional money against the equity. The loan amount is based on the borrower's income and credit history as well as the current market value of the property, less any existing liens. The term of a closed-end HEL is typically 15 years.
When deciding to take out a home equity loan, homeowners should become familiar with several relevant financial terms and consider their implications. As applied to their own situations, borrowers need to know the meanings of recourse and nonrecourse loans, or debts, secured debt and unsecured debt, and dischargeable debt and nondischargeable debt.
A recourse loan, or debt, requires the borrower to remain personally liable for the debt on a foreclosed property. In other words, if the property used as collateral is foreclosed without the HEL having been paid, the borrower loses the property but still owes the lender the amount of the loan made against its equity.
A nonrecourse loan, or debt, allows the borrower not to be personally liable for the HEL if the property is foreclosed. If the property is lost to foreclosure, repaying the HEL is not necessary.
Secured debt means that a real asset, in this case the borrower's home, is used as collateral to secure the loan. If the borrower defaults on the loan, the lender can take possession of the property and sell it to recoup the outstanding amount of the HEL.
Unsecured debt has no high-value asset pledged as collateral that the creditor can seize and sell in case the borrower defaults. Unsecured loans are considerably riskier for the creditor or lending institution and carry higher interest rates than secured loans do. By using a HEL to settle credit card debt, a homeowner effectively pays unsecured credit card balances by means of a financial vehicle that is secured. The amount of the HEL is still owed, but the interest rate is usually less and repayment term is fixed.
Dischargeable debt is debt that can be dismissed through bankruptcy proceedings. Conversely, nondischargeable debt cannot be dismissed by successfully filing bankruptcy. Bankruptcy law defines which types of debt are eligible for being discharged.