With the current popularity of loans based upon home equity, a lot of people find themselves wondering exactly what equity is and how it's used.

If you're one of these people, take heart by the end of this article you'll have a much better understanding of home equity and exactly what happens when you take out a home equity loan or a home equity line of credit.

First of all, though, you need to learn what home equity is and how it is created.

Defining home equity

Home equity is an often-used term in the advertising of financial services these days, but most of the ads that use it don't bother explain what home equity is.

At its most simple, home equity is the amount of the house or other real estate that you actually "own" it's the portion of the mortgage on the property that you've actually paid off.

A house that was purchased a few months ago will have little to no equity, since at best only a few payments have been made toward the mortgage amount; a house that was purchased 15 years ago, though, will have a good portion of the mortgage paid off and will therefore have quite a bit of equity built up.

The more equity there is in a piece of real estate, the more valuable that property is in the eyes of lenders after all, that's a much smaller portion of the property's value that still has to be paid off.

Using your equity

In order to use your equity effectively, you'll have to use it as collateral for a loan or a line of credit. The amount of equity that you have available will be a major factor in the amount of interest that you pay and the loan terms that you are subjected to; the more equity that you have in your home, the lower the amount of the home that's still left to be paid off should you not make you loan payments on time.

Of course, there are a few differences between home equity loans and home equity lines of credit each can be used in specific ways, and the situation that you plan to use them in can determine which of the two is the better choice for your needs.

Home equity loans

A home equity loan is a specific amount that you borrow from a bank or other lender and that is going to be used for a specific purpose.

A home equity loan can be used to pay for a variety of expenses, such as automotive financing, debt consolidation, or home improvements, or it can even be used to refinance the mortgage at a lower interest rate and monthly payment.

The important thing to remember is that home equity loans are of a specific amount, so the entire amount must be paid back to clear the loan.

Home equity lines of credit

As opposed to a home equity loan, a home equity line of credit sets a maximum amount that can be used (based upon the available equity) and allows the homeowner to use whatever portion of that amount best suits their needs.

This works in much the same way as a credit card, and allows for purchases over a longer period of time without having a specific set amount to repay.

Home equity lines of credit are often used for home improvements or when multiple purchases need to be made without knowing the total cost of all of them.

You may freely reprint this article provided the following author's biography (including the live URL link) remains intact:

About The Author