If you need money and have paid off a decent chunk of your mortgage, a home equity loan can be a tempting option.
These loans generally carry lower interest rates than other consumer loans, because they are secured by real estate.
Using your home as collateral isn’t an issue if the borrowing terms are reasonable and your finances are in order. Nevertheless, it can quickly turn into a nightmare under the wrong circumstances. Fail to keep up with repayments and you risk losing your property and maybe even getting sued.
What Are Home Equity Loans?
A home equity loan basically enables you to use your home equity as collateral to borrow a lump sum of cash. So, for example, if your property is valued at $500,000 and you owe $200,000 on your first mortgage, you have $300,000 in equity that can be used as a guarantee for a second loan.
Lenders will offer more-competitive borrowing rates if you use your house as collateral, because it gives them something valuable to seize and sell to recoup some or all of their losses in the event that you are unable to keep up with payments. This means cheaper loans but also the risk of losing your house if you default.
What Happens if I Don’t Pay My Second Mortgage?
If you are for whatever reason unable to repay a home equity loan, the lender may choose to foreclose on the house you used as collateral. The creditor’s actions usually depend on the value of your home, whether there are any other liens against it, and how much money you still owe.
When a borrower defaults on their first mortgage, the loan used to buy the home, lenders are highly like to begin foreclosure proceedings to get their money back. Whether this same approach is adopted on a second mortgage depends on the property’s value and how much equity the borrower has in it.
This is because the first mortgage lien, by virtue of being recorded in the county land records earlier, is given higher priority. Thus, if you fail to repay your home equity loan and the secured house is sold to satisfy the debt, the proceeds will first be used to extinguish whatever is left to pay on the initial mortgage. The second mortgage lender can only begin to collect what it’s owed once the more senior lien has been honored and paid off.
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