A home is generally a valuable asset and its prices tend to rise over time. Once you have accumulated a decent amount of real estate capital, your stake can be used to get a nice big cash injection to spend on whatever you want.
However, this privilege comes at a cost. In exchange for lending you large sums of money at rates that are usually better than you would get with an unsecured personal loan, the financial institution will put a lien on your property.
Key points to remember
- A home equity loan allows you to use the equity in your home as collateral to borrow a lump sum of money.
- The loan is secured by the property in the form of a lien, which means the lender has permission to foreclose on your home if you fail to keep up with repayments.
- With the lien, the lender has a right to something of value that they can seize and sell if necessary to recover what is owed to them.
- The lien remains in place until the debt is repaid.
- If you are still paying off the mortgage on your home, the home equity loan becomes a second mortgage (also known as “secondary debt” or “junior debt”).
What is a privilege?
A lien is a legal claim or right to a property. Essentially, lien holders are allowed to sell the asset in question if an underlying obligation, such as repayment of a loan, is not honored.
Liens are attached to certain types of loans to protect the lender in case the borrower fails to meet their contractual obligations and miss their payments. With the lien, the lender has a right to something of value that they can seize and sell if necessary to recover what is owed to them. In other words, when someone places a lien on your property, it effectively becomes security for the debt.
These legal claims are usually public information, meaning anyone can see if a creditor has a hold on a particular asset, and they stay in place until the debt is repaid. While the lien is in effect, the borrower’s title to the property is not legally clear and technically he does not have complete ownership.
Links can usually be found online, as many government agencies now store public information digitally.
Does a home equity loan create a lien against your title?
Home equity loans allow homeowners to use the equity in their home as collateral to borrow a lump sum of cash. The loan is secured by the property, so if you don’t meet the repayments, the lender can sell the house to recover what is owed to them.
If you are still paying off the mortgage on your home, the home equity loan becomes a second mortgage (also known as “secondary debt” or “junior debt”). This means that in the event of non-payment and subsequent liquidation of the guarantee, the original mortgage is the first to be collected. The second mortgage lender can only begin to collect its debt once the oldest lien has been honored and repaid.
This situation sometimes causes the lender to also look for other assets that you own. If the proceeds of seizure are not enough to clear the debt, you may be hit with a deficiency judgment, which gives the lender permission to seize bank accounts, garnish wages, and place liens on d ‘other properties to recover the outstanding balance. With recourse loans, the creditor can go beyond liquidating the security to recover what is owed to them.
Where there is a first mortgage, the second will often carry higher interest rates, as its lien is subordinated and therefore less valuable.
Is a privilege good or bad?
Giving a lender the legal right to foreclose on your home cannot be described as a good thing. It is necessary with a mortgage, however, and can actually, believe it or not, be beneficial if you have no problem repaying the money that has been loaned to you.
When you offer your house as collateral, the loan becomes less risky for the lender. With the lien, the bank doesn’t have to worry so much about the borrower’s potential default because they have another way to get their money back. This lower risk translates into more attractive borrowing costs, expressed as interest rates.
Loans with liens carry lower interest rates than unsecured debt.
It’s also worth remembering that a bank with a lien on your property can only seize the asset if you fail to meet your contractual obligations. If you keep paying and do what you promised, the lien shouldn’t harm you or have any noticeable negative repercussions.
Problems arise when borrowers encounter financial difficulties. If you lose your job or a key source of income and have little savings, that home equity loan that seemed like such a great idea might come back to bite you. Stop paying and the lender has the right to foreclose, evict you from your home and leave you homeless.
There is also the risk that property values will drop and push you “under water”, meaning you owe more on the loan than the house is worth. Having a mortgage that exceeds the value of your home may sound unbelievable, but it’s happened to many people and it’s not a good place to live.
What happens when you default on a home equity loan?
Home equity loans are secured loans, which means that if you don’t meet the repayments, the lender has the right to sell your home to collect what’s owed to them.
What is the difference between a first mortgage and a second mortgage?
Many people with a home equity loan are also paying off the mortgage used to purchase their home. When this is the case, the home equity loan is structured as a second mortgage. The first mortgage has priority over the second when claiming the guarantee. In other words, the new lender can only exercise its right to collect its lien after the first mortgage is paid off.
Can you sell your house if you have a home equity loan?
You are free to put your home up for sale without settling a home equity loan or other liens. However, if the sale goes through, you will have to repay the lien claimant on your home title with the proceeds.
Home equity loans and their attached liens are not necessarily bad for homeowners. These guarantees make it cheaper to borrow money and will not cause harm if the borrower sticks to the agreement.
Whenever you take out a loan, you should be aware that there will be repercussions if you don’t repay it as agreed. With a home loan, it’s your home that’s at stake, which is why it’s so important to fully understand the repayment terms and conditions before committing.
A home equity loan can be a great way to get a relatively cheap cash injection. But if you are unable to meet the payments, it can also turn into a nightmare and leave you homeless.