Are home equity loans secured loans?
With a home equity loan, you use your home’s equity to obtain a loan, using your home as collateral against it. A loan is secured when the lender can know that, even if the borrower defaults on the loan, the lender will be able to earn back the value of the remaining loan through a secured asset, such as a home.
Below, we’ll dive deeper into what home equity loans are and explain how and why home equity loans are secured loans.
What are home equity loans?
There are typically three types of home equity loans you can choose from: traditional home equity loans, home equity lines of credit (HELOCs), and refinancing using home equity. Let’s take a closer look at each type.
Traditional home equity loan
Home equity loans can give you the chance to tap into your home’s equity (the difference between the value of your home and the amount you owe on your mortgage) to receive one lump sum of money.
Once you receive the lump sum, you will repay the loan with fixed monthly payments over a certain term. If you know exactly how much money you need to borrow, a home equity loan may be preferred over a home equity line of credit.
Discover® Home Loans offers home equity loans for amounts between $35,000 - $300,000 with no application, origination, or appraisal fees, and no cash is required at closing.
Home equity line of credit (HELOC)
HELOCs are revolving lines of credit. If you take out a HELOC, you can borrow money up to a set credit limit. When your financial needs are more flexible, a HELOC allows you to withdraw only what you need and charges interest only against that amount.
If you opt for a HELOC, there are two time periods you should be aware of: the draw period and the repayment period. During the draw period (which usually ranges from 5 to 10 years), you can withdraw the amount of money you need up to your limit. Some HELOCs allow you to only make interest payments (where you don’t have to repay the principal) during the draw period—meaning lower monthly payments during this period.
Once the draw period is up, the repayment period (which is typically 10 to 20 years long) goes into effect, and you won’t be able to withdraw any more money from the line of credit. During the repayment period, you’ll be required to pay back both the principal and interest on the amount you borrowed, so your monthly payments may increase compared with the payments you made during the draw period.
Home equity refinancing
You can use a new home equity loan to refinance a first mortgage, home equity loan, or HELOC. If you’d like to refinance your mortgage at a lower rate, secure different loan terms, or get cash out of your home to use for expenses, you may want to go this route.
Ideally, you’d refinance your mortgage with a home equity loan when you have significant equity in your home and/or locked in your original or second mortgage when rates were higher.
Discover Home Loans offers a mortgage refinance option with zero origination fees, zero application fees, zero appraisal fees, and low, fixed rates for first liens.
You can use a new home equity loan to refinance a first mortgage, or obtain a home equity loan, or HELOC.
What are secured loans?
A secured loan requires you to put up an asset (such as a house or car) as collateral. The most common types of secured loans are auto loans, mortgages, home equity loans, and HELOCs. If you take out a secured loan, you can typically borrow a larger amount of money because of your promise to give up your collateral asset to the lender if you are unable to repay the debt. As the lender is taking on less risk because of your promised collateral, they typically extend lower interest rates and larger limits on your borrowing.
What are unsecured loans?
Unlike a secured loan, an unsecured loan isn’t backed by collateral like a house or car. Credit cards, student loans, and personal loans are a few examples of common unsecured loans.
Since there is no collateral involved with an unsecured loan, you may pay a higher interest rate given the higher risk of defaulting on the loan.
Secured vs. Unsecured Loans
|Typical Interest rate factors
|Loan Amount Limits
|Combined-loan-to-value ratio, your debt-to-income ratio, length (term) of loan, amount borrowed, and your credit score.
|Lower. If you have equity in your home, you may be able to take out a home equity loan. Some secured loans, like a Discover Home Loan, have minimum credit score requirements of 660.
|Higher. You can gain access to larger amounts of money because of your collateral.
|If you default on your home equity loan, the lender may initiate foreclosure and take your home. Also, your credit score may suffer.
|Your debt-to-income ratio, length (term) of loan, amount borrowed, and your credit score.
|Higher. The higher your credit score, the more likely you are to get approved. Higher credit scores also can secure lower interest rates and favorable terms.
|Lower. Since your loan won’t be secured by collateral, you’ll be a greater risk to the lender and therefore be able to borrow less.
|If you default on an unsecured loan, your credit score may suffer. In addition, you can be sued or face collection agencies.