Equity is the difference between how much the home is actually worth and how much you owe on the mortgage or mortgages, if you already have a home equity loan or line of credit. The worth of the house can go up and down depending on repairs and the market. If the market turns very bad for your house, you can actually have negative equity and owe more on your house than it is worth. Optimally, your house will go up in worth and you will have what you have already paid off as well as the added value of the house as equity. There are two ways to get money by offering your house as collateral, also known as getting a second mortgage. But with each of them, you have to pay off the balance when you sell the house.
With the first type, home-equity loans, you're given a certain amount of money which you typically receive all at once and pay back according to a set schedule in fixed payments at a fixed interest rate. This type of loan is called an installment loan and you know exactly what you’re getting and what you’re giving when you get it. Home equity loans and lines of credit usually are repaid in a shorter period than first mortgages, having between five and 30 years to repay the loan. Once you get the money, you cannot borrow further from the loan.
Home-equity lines of credit are very similar to credit cards, except in this case the bank knows they’ll get their money because you’re putting your house on the line for the credit. You're given a credit limit that you can borrow against, and paying down your debt frees up more credit that you can potentially spend. However, home-equity lines of credit have variable interest rates so you don’t know what you will be paying in interest a year after you take out the money. These are usually not open-ended. For a pre-determined amount of time known as the “draw” period, you can borrow as much as you’d like within your pre-set credit limit, and you only need to pay the interest charges although you can elect to pay principal. However, after this period of time is over, you can no longer draw anymore and you need to start paying principal as well as interest.
