A home equity loan or a home equity line of credit allows you to borrow money, using your home as collateral. Collateral is property that you pledges as a guarantee to the creditor (e.g. a bank) that you will repay the debt. For example, a consumer may pledge his/her home as the collateral.

Equity is the difference between how much the home is worth and how much you owes in mortgage(s). For instance, you take a loan from a bank to buy a house. The house you buy is worth 300,000 pounds, and when taking the home equity loan, you made a down payment of 100,000 pounds to the bank. So in effect, you are borrowing 200,000 pounds from the bank.

The equity at this point is equal to the down payment, i.e. 100,000 pounds. Let's say, after five years the value of your house shoots up to 400,000 pounds. Also assume that you have paid back 25,000 pounds to the bank. Now, you owes 175,000 pounds to the bank. The equity = present market value of the home - amount owed by consumer to the bank = 400,000 pounds - 175,000 pounds = 225,000 pounds.

Hence, home equity loans or home equity lines of credit are second mortgages which, like the primary mortgage, are secured by your home. The first mortgage or primary mortgage was the loan you took to buy the house. You are eligible for the second mortgage i.e. the home equity loan, because the value of your property has increased with time and are worth more. The interest rate for the home equity loan i.e. the second mortgage is higher than that for the first mortgage because the risk involved for the lender of the second mortgage is higher. This is because if, the first mortgager has the first lien on the property, the second mortgager-the bank, giving the home equity loan-takes on the added risk of being second in line to collect if the borrower defaults.

The great disadvantage of home equity is that if you do not make payments on time or unable to make the loan payments, then, in this case, you run the risk of losing the collateral.

So, once again the same home which has a higher value now, is the collateral. This second loan i.e. home equity is usually used for home improvements, debt consolidation, college education or other expenses. However, the same risk applies to this equity debt or second mortgage, i.e. if the consumer fails to make his/her payments, the creditor may take possession of the house.