Home equity loan

Key Takeaways

• A home equity loan advances the entire amount in one lump sum at closing and is repaid on a fixed schedule.
• The amount available is sized by equity, which is the property's current market value minus the balances owed against it.
• A home equity line of credit revolves and is drawn as needed, while a home equity loan pays out once and does not revolve.
• In Washington a home equity loan is secured by a deed of trust recorded against the property, normally in second position behind the purchase loan.

What It Means

A home equity loan is a second loan taken against a house the borrower already owns, paid out as a single lump sum and repaid over a set term at a set payment. It is sized by Equity, the property's market value minus what is still owed against it. If a house is worth $500,000 and the purchase loan balance is $300,000, the owner holds $200,000 of equity, and the lender will advance some fraction of that figure rather than all of it.

The loan does not replace the first loan and does not change its rate or its term. It sits behind that loan as a separate debt with its own promissory note and its own security instrument, which is why it is often called a second mortgage. It is secured by the house, so missing payments on it puts the property at risk the same way missing payments on the first loan does.

The contrast students are asked to draw is with a Home Equity Line Of Credit Heloc. A line of credit sets a limit the owner draws against, repays, and draws again, so the balance and the payment move. A home equity loan hands over the whole amount once.

How It Works in Washington

In Washington the security instrument behind a home equity loan is a deed of trust, not a two-party mortgage. RCW 61.24.020 provides that a deed conveying real property to a trustee in trust to secure the performance of an obligation of the grantor or another to the beneficiary may be foreclosed by trustee's sale, and that except as chapter 61.24 RCW provides, a Deed Of Trust is subject to all laws relating to mortgages on real property. The equity lender records its deed of trust as soon as the loan closes, because under RCW 65.08.070 an unrecorded conveyance is void as against any subsequent purchaser or mortgagee in good faith and for value whose conveyance is first duly recorded. The purchase loan recorded years earlier normally stays ahead of it.

Priority is what matters when something goes wrong. RCW 61.24.100(1) provides that, except to the extent the section permits for deeds of trust securing commercial loans, a deficiency judgment shall not be obtained on the obligations secured by a deed of trust against any borrower, grantor, or guarantor after a trustee's sale under that deed of trust. Read the words closely, because the protection attaches to the deed of trust that was foreclosed. A Washington homeowner facing a senior lender's trustee's sale with a home equity loan sitting behind it should get legal advice about that junior debt rather than assume it goes away with the property.

Example

Renee owns a house in Tacoma that appraises at $560,000. Her purchase loan balance is $340,000, so her equity is $220,000. Her credit union will lend on a home equity loan up to a combined Loan To Value Ratio of 85 percent. Eighty-five percent of $560,000 is $476,000; subtract the $340,000 first loan and the most she can borrow is $136,000.

She takes $120,000 as a lump sum at a fixed rate over 15 years to pay for a new roof and a kitchen remodel. At closing the credit union records a second deed of trust against the house. Her balances now total $460,000 against a $560,000 value, a combined loan-to-value of about 82.1 percent, and her remaining equity is $100,000. Her first loan payment does not change. She simply has a second payment beside it, and both are secured by the same house.

Common Mistakes and Exam Traps

• A home equity loan is a lump sum with a fixed repayment schedule. A home equity line of credit is a revolving limit the owner draws and repays, which is the swap most often tested.
• A home equity loan is a new junior loan, not a refinance. The first loan stays in place with its original rate and term.
• Equity is measured against current market value, not against the original purchase price.
• In Washington the instrument securing the loan is a deed of trust with a trustee, so an answer describing a two-party mortgage foreclosure does not match Washington practice.