Sara Routhier, Managing Editor of Features and Outreach, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming worl...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Sep 19, 2011

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Borrowers who need money to pay for a large expense like college, medical bills or home repair costs can apply for a home equity loan, which uses the borrowers’ house as collateral for the loan. This is often termed a “second mortgage,” and places a lien against the home to back the loan.

This kind of loan generally has a fixed interest rate, regular monthly payments and is paid off over an extended period of time. This can often be a better option than other forms of debt like credit cards that are unsecured because it usually has a lower interest rate. Also, the interest is almost always tax deductible. Home equity loans can be good for borrowers whose homes have increased in value since the original purchase.

The money can be used for anything the borrower needs it for, even to pay off debt from other accounts in a debt consolidation loan. To find out the value of a home equity loan, the borrower can add the balance of all the debts secured by the home (essentially, how much the borrower owes on the existing mortgage) and subtract that from the home’s value.

Borrowers must also consider the loan-to-value ratio (LTV), which is the comparison of the value of the home and the loan amount. A higher LTV generally means a higher cost loan.

However, this manner of securing extra cash can also be dangerous, as there are many lenders – called predatory lenders – that take advantage of low income home owners. The Federal Reserve Board warns that these lenders “target homeowners who have low incomes or credit problems or who are elderly by deceiving them about loan terms or giving them loans they cannot afford to repay.”

Another similar option for funding based on home equity is a home equity line of credit (HELOC), which functions more similarly to a credit card. The borrower can take out money periodically during the life of the loan, a time period determined by the lender. During that period, the borrower can take out money as he or she needs it and pay back only the interest each month. This gives more flexibility but also less predictability since the interest rate is not fixed.